Thank You, George Cohan: A Gambler Gets Lucky

George Cohan is known as “the man who owned Broadway.” He also proved quite helpful to a gambler today at the US Tax Court.

Jose Caro liked horse racing. Any and every day he could, he went to the track and bet on the races. Sometimes he won, but for the most part he lost. He also has had experience dealing with the IRS.

Some time ago he was audited, and he survived with a “no change” audit. For record-keeping, he put all of his losing betting slips and any W-2Gs and other items noting the amount won inside of the program for each day. He then taped the programs shut and noted the amount won and lost on the outside of the program. That’s a good example of keeping contemporaneous records.

Unfortunately for Mr. Caro, he made a mistake in choosing his accountant. The unnamed individual made numerous mistakes with his return, leaving off $70,883 in wins. When the IRS again audited him the accountant vanished into thin air, along with Mr. Caro’s records. The gambler believed that he had numerous losses that could be taken, but with no records the IRS disallowed the additional $70,883 in gambling losses. That’s where Mr. Cohan comes in.

Back in 1930, George Cohan was one of the first victims of a tax audit (from the then Bureau of Internal Revenue). Mr. Cohan couldn’t produce all of his records, and the Bureau disallowed his deductions. He appealed to the Board of Tax Appeals and lost. He then took his case to court.

Here’s the key point of the court decision:

In the production of his plays Cohan was obliged to be free-handed in entertaining actors, employees, and, as he naively adds dramatic critics. He had also to travel much, at times with his attorney. These expenses amounted to substantial sums, but he kept no account and probably could not have done so. At the trial before the Board he estimated that he had spent eleven thousand dollars in this fashion during the first six months of 1921, twenty-two thousand dollars, between July first, 1921 and June thirtieth, 1922, and as much for his following fiscal year, fifty-five thousand dollars in all. The Board refused to allow him any part of this, on the ground that it was impossible to tell how much he had in fact spent, in the absence of any items or details. The question is how far this refusal is justified, in view of the finding that he had spent much and that the sums were allowable expenses. Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making. But to allow nothing at all appears to us inconsistent with saying that something was spent. True, we do not know how many trips Cohan made, nor how large his entertainments were; yet there was obviously some basis for computation, if necessary by drawing upon the Board’s personal estimates of the minimum of such expenses. The amount may be trivial and unsatisfactory, but there was basis for some allowance, and it was wrong to refuse any, even though it were the travelling expenses of a single trip. It is not fatal that the result will inevitably be speculative; many important decisions must be such. We think that the Board was in error as to this and must reconsider the evidence. [emphasis added]

Today, this is called the Cohan Rule: A taxpayer can use estimated when he can show some factual foundation to make a reasonable estimate of the expense.

Mr. Caro’s records, through no fault of his own, vanished with his accountant. The Tax Court noted:

Petitioner was a compulsive gambler who gambled every day possible. We are confident after hearing his testimony that petitioner placed as many losing bets as he did winning ones…Instead, he often depended on his grown children for help in paying his bills. We are convinced that petitioner sustained unreported gambling losses that were sufficient to offset his unreported gambling income for 2006. Petitioner’s credible and convincing testimony regarding the extent of his gambling losses, together with the other evidence, provides a sufficient basis for this decision.

The petitioner prevailed without records thanks to the Cohan rule. Do note that it is far easier to win at an audit if you have contemporaneous records, and you usually won’t need to go through the expense of a case at Tax Court.

Case: Caro v. Commissioner, T.C. Summary 2009-184


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