At Moseley & Associates, we get questions all the time about how long to keep your tax documents. A recent Tax Court Case (Koriakos, TC Summary Opinion 2014-70TC Summary Opinion 2014-70) gives us some nice reminders about how long to keep the materials supporting the deduction claims on your tax return. In this case, the taxpayers tried to deduct charitable contributions and business expenses without substantiation. They claimed to have inadvertantly shredded documents as part of a move from Airzon to Florida and didn't have back-up to support their claims.
Under the Cohan rule (named after George M. Cohan, the famous American composer and entertainer), if a taxpayer establishes that an expense is deductible but is unable to substantiate the pricse amount, the court may estimate the amount, "bearing heavily against the taxpayer whose inexactitde is of his own making." (Cohan v. Commissioner, 39 F. 2d 540 (2d Cir. 1930)). To make an estimate, the court needs something to work from and that something needs to be useful and reliable. In the Korakos case, the Cohan rule did not fly. The taxpayer records didn't show any evidence for the market value of the donated items and the court could not estimate any charitable amount using the Cohan rule, "for to do so would amount to unguided largesse." The taxpayer has a similar result with the business expenses. The court noted that while shredding may have not been on purpose, it was not out of the taxpayer's control in way that fire, flood, or earthquake would have been. “Even if such happenstance was inadvertent, it was not a circumstane beyond their control, and they must accept the consequences of their carelessnes. Consequently, [the tax code] affords no relief.”
The quality of support provided when records are not available seems to have a large bearing in this case. Read between the lines to hear the disgust the Judge Armen has for these taxpayers. “We begin with the $5,500 deduction for ‘office expense’, for it is illustrative of the shortcomings in the evidentiary record that inform our ultimate holding. Thus, according to petitioners, this deduction represents $3,000 for telecommunications and $2,500 for undientified ‘one time expenses’. Insofar as the latter are concerned, petitioners speculate that such unidentified expenses may be for ‘this’ or may be for ‘that’. But if petitioners do not know for sure and are left to guess what expenses they are seeking to deduct, any allowance under the Cohan doctrin is foreclosed.” At another point, the judge calls the taxpayer testimony “singularly unpersuasive.”
So, dear taxpayers, the lesson is clear. Keep your tax “stuff”! And, if you lose it or don’t have it, figure out a way to reliably and convincingly reconstruct it.