Tax Court Update: Basis for Cohan Rule by Jonathan Kalinski
As we approach the tax return filing deadline of April 17 this year, taxpayers are scrambling for documents to substantiate their expenses and basis in assets. Tax practitioners are always asked low long should one keep records. Three years? Seven years? Forever? If you find yourself without records, all may not be lost thanks to early 20th century Broadway writer, producer, director George M. Cohan.[i]
Andrew Shank[ii] withdrew over $27,000 from his IRA and did not report any of it on his tax return despite receiving a Form 1099-R. At trial he credibly testified that he opened the IRA in the 1990s when he was a high earner and therefore could not deduct the contributions. The Court found it understandable that Mr. Shank didn’t have records from the 1990s and combined with his credible testimony used the Cohan rule to estimate his basis. Although the Court ultimately determined a basis of only $4,760, there are several important lessons from this case.
First, although documentary evidence might be the best evidence to prove basis, testimony is evidence and credible testimony is valuable evidence. IRS Revenue Agents, Appeals Officers, and even lawyers frequently get tunnel vision and only look at documentary evidence and ignore the taxpayer’s words. If a taxpayer can credibly tell his or her story the Court will consider it even where recordkeeping is light. As a practitioner, you need to build your case around your client’s story to offer as much support as possible. Cohan is not automatic. You must establish a reasonable evidentiary basis.
Second, this case serves as a reminder that the Cohan rule does not only apply to expenses, but also basis. Taxpayers are frequently trying to prove their basis in stocks purchased years ago, or the cost of home improvements. These issues are ripe for the Cohan rule, assuming you can establish a reasonable evidentiary basis.
Finally, when it comes to keeping records, if it deals with basis, it is wise to keep records for several years after you dispose of the asset. Without records you may not end up with zero basis, but even with Cohan, it is unlikely to be what you think you deserve.
[i] Cohan was famously portrayed by James Cagney, who won an Oscar for Yankee Doodle Dandy. https://www.youtube.com/watch?v=StDpLge_ITM
[ii] Shank v. Commissioner, T.C. Memo. 2018-33.