Estimates and the Cohan rule.

• Author: Brophy, Joseph D.

When dealing with clients who have incomplete records, return preparers are frequently forced to use estimates whether they want to or not. A recent Fifth Circuit decision that a district court should consider estimates--using the Cohan rule as guidance--when taxpayer records do not strictly comply with the Sec. 41 research credit regulations serves as a reminder that practitioners also have a responsibility to clients to consider estimates while preparing many tax filings.

In McFerrin, No. 08-20377 (5th Cir. 6/9/09), the taxpayer owned several S corporations. McFerrin was a well-known and respected chemical engineer. For the 1999 tax year, McFerrin's companies did not claim an R&D tax credit but later filed amended returns that included the credit. The IRS issued a refund but later sued McFerrin for return of the refund on the grounds that McFerrin was not entitled to the credit and that it had issued the refund erroneously.

The IRS argued that even if McFerrin had incurred creditable expenses, he was not entitled to the credit because he had failed to substantiate his claim. The parties agreed that McFerrin had not strictly complied with the record-keeping...