To get back to the original question about the Cohan rule - I'm a bookkeeper and see clients try to abuse this all the time. They'll come in with almost no records and expect to claim thousands in deductions "because of the Cohan rule." The reality is much different. In practice, the IRS is very strict about applying this rule, especially for theft losses. They typically expect: 1. A timely filed police report 2. Insurance claim documentation 3. Original purchase documentation or other proof of value 4. Evidence that you've exhausted recovery options Even with all that, they often allow only a percentage of the claimed amount when the Cohan rule is involved. And they're much more likely to scrutinize these claims during an audit. The bottom line: Can you "get away" with claiming fake theft losses? Maybe in the short term, but it's fraud, and if you're audited, you'll face serious consequences including penalties, interest, and potential criminal charges for tax evasion.

Small business owner here. I've been through two IRS audits in my 15 years of running my company. Here's my experience with the Cohan rule: The rule CAN be helpful when you have some documentation but not complete records. During my first audit, I had incomplete mileage logs but could prove my business travel through appointment calendars, receipts from destinations, etc. The auditor allowed a reasonable percentage of my claimed mileage using the Cohan principle. BUT - and this is a huge but - they will give you ZERO leeway on completely undocumented claims or things that seem fabricated. My second audit involved a contractor who gave me fake documentation for some work, and even though I genuinely paid for services, the IRS disallowed the entire deduction because they determined the documentation was not credible. Claiming fake theft losses would fall under fraud, not the Cohan rule. The rule helps honest taxpayers with imperfect records, not dishonest ones trying to create deductions.

I went through almost the exact same situation last year. The key is to NOT agree to the audit results until the withholding issue is resolved. Once you agree to the assessment, it's much harder to fix. Instead of following the auditor's advice, I submitted a formal response to the audit stating that I agreed with the tax assessment BUT noted that my W2 withholdings of $X amount hadn't been included in the calculation. I included copies of my W2s and requested that penalties be calculated only on the actual amount owed after withholdings. It took about 3 weeks longer, but they eventually sent a revised audit result that properly accounted for my withholdings and the penalties were calculated correctly from the start. Don't pay anything until this is straightened out!

Just to add another perspective - what the auditor told you is technically correct in terms of IRS procedure, but it's inefficient and potentially costly for you. The IRS often has different departments handle tax assessment (audit) and payment processing. When your audit is closed, your account should eventually reflect both the increased tax assessment AND your withholdings, but there can be timing gaps where penalties are calculated incorrectly. If you do follow the auditor's advice, make sure to follow up after paying to request a penalty abatement for the portion calculated on taxes you already paid through withholding. You can use IRS Form 843 for this. Include copies of your W2s showing the withholding.

I dealt with this exact K-1 nightmare last year. One option nobody's mentioned yet is to talk to the partnership itself. Sometimes they can make a special tax distribution just to cover the taxes on phantom income. In my case, I showed the managing partner my tax projection and they agreed to distribute enough cash to cover the extra tax burden. Also, check if your partnership agreement has any provisions about tax distributions. Some partnerships are required to distribute at least enough to cover each partner's tax liability on allocated income.

Has your accountant discussed form 8582 with you? That's the form for calculating passive activity limitations. Sometimes accountants miss opportunities to group activities together to meet material participation standards. You might also want to check if you qualify for the real estate professional exception if this is a real estate partnership.

One thing nobody's mentioned yet - check if you're still within the timeframe for a "corrective distribution" for your 2022 overcontribution. If you took the distribution before your filing deadline (including extensions) for 2022, you can avoid the 6% excise tax completely, even if Vanguard coded it incorrectly on the 1099-R. For the earnings portion, you generally need to include those as income in the year you made the contribution (2022), not when you took the distribution (2023). If your 1099-R doesn't separately show the earnings, you might need to contact Vanguard to get that breakdown. The most critical form here is Form 5329 where you'll need to show you corrected the excess contribution. Even with an incorrect distribution code, you can still properly document this with an attached statement explaining the situation.

Heads up - I went through this exact same mess with Fidelity last year. Make sure you also check if you qualify for the "self-certification" procedure under Revenue Procedure 2021-30. If your correction doesn't fully meet all the technical requirements for a proper return of excess contribution, you might still qualify for relief under this procedure. It essentially lets you "self-certify" that you intended to follow the rules for proper correction even if there were some procedural errors along the way. You'll need to file a specific statement with your return, but it could help avoid penalties even if Vanguard didn't process everything perfectly.

One extra tip: if you're filing multiple back years, don't use the standard Free File options. They usually only support the current and maybe previous year. I had to file 3 years back and ended up using FreeTaxUSA which supports filing returns back several years for a reasonable fee. TurboTax wanted a fortune for each past year. Also, set up an IRS online account NOW, before you need it. It takes a couple of weeks sometimes to verify your identity, and you'll want access to view your transcripts and track your refunds.

Has anyone been audited after filing multiple years of back taxes? I'm in a similar boat (4 unfiled years) and paranoid that suddenly filing everything will trigger an audit.