Cohan v. Commissioner, 39 F. 3d 155 (9th Cir. 1994)

Deductions for business expenses must be substantiated with adequate records or sufficient evidence, even if records were once maintained but subsequently lost.

Summary

In Cohan v. Commissioner, the taxpayer sought to deduct various business expenses but failed to provide adequate substantiation as required by section 274 of the Internal Revenue Code. Although the taxpayer had initially maintained records, these were lost due to marital issues, which the court did not consider a casualty beyond the taxpayer’s control. The court emphasized that without the lost records or sufficient reconstruction of the expenses, the taxpayer could not claim the deductions. This case underscores the stringent substantiation requirements for business expense deductions and the importance of maintaining and preserving adequate records.

Facts

The taxpayer attempted to deduct entertainment expenses, business gifts, air travel costs, and club dues as ordinary and necessary business expenses under section 162. He had maintained a voucher system that adequately recorded these expenses, but these records were lost due to marital difficulties. The taxpayer argued that he should be exempt from the substantiation requirements of section 274 because he had once possessed adequate records. However, he could not provide any detailed reconstruction of the lost records or any corroborating evidence regarding the expenses.

Procedural History

The taxpayer filed for deductions on his tax return, which were disallowed by the Commissioner. The taxpayer then petitioned the Tax Court, which ruled in favor of the Commissioner due to lack of substantiation. The taxpayer appealed to the Ninth Circuit Court of Appeals, which affirmed the Tax Court’s decision.

Issue(s)

1. Whether a taxpayer who once maintained adequate records but subsequently lost them due to circumstances not considered a casualty under the tax regulations can still deduct business expenses without those records.

Holding

1. No, because the loss of records due to marital difficulties does not qualify as a casualty under the regulations, and the taxpayer failed to reasonably reconstruct the records as required.

Court’s Reasoning

The court applied section 274(d) of the Internal Revenue Code, which mandates that taxpayers substantiate entertainment, gift, club, and travel expenses with adequate records or sufficient evidence. The court noted that the Treasury regulations allow an exception if records were lost due to a casualty beyond the taxpayer’s control, but marital difficulties were not deemed a casualty. The court cited previous cases where similar losses of records were not considered casualties. Furthermore, the court found that even if a casualty had been established, the taxpayer did not meet the requirement of reasonably reconstructing the lost records. The court emphasized the need for detailed information about the expenses, which the taxpayer and his witness failed to provide.

Practical Implications

This decision reinforces the strict substantiation requirements for business expense deductions. Taxpayers must maintain and preserve adequate records, as the loss of records due to non-casualty events does not exempt them from these requirements. Practitioners should advise clients to keep meticulous records and have backup systems in place. The ruling also affects how similar cases are analyzed, emphasizing the need for reconstruction efforts if records are lost. Subsequent cases have applied this ruling to uphold the substantiation requirement, impacting tax planning and compliance strategies.