Tax Court in Brief | Showalter v. Comm’r | IRS Adds to Taxable Income Based on Taxpayer Bank Records

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Tax Litigation:  The Week of November 28th, 2022, through December 2nd, 2022

Showalter, v. Commissioner, T.C. Memo. 2022-114 | November 30, 2022 |Lauber, J.| Dkt. No. 13116-18

Short Summary: This case involves whether a taxpayer has additional unreported income based on the deposits in its company’s bank account. Richard Showalter (Showalter) is the sole owner of Real Estate Consulting Services, LLC (RECS). RECS has only one bank account. Showalter did not file his 2013 tax return. The IRS issued a substitute for return as provided in 26 U.S.C. § 6020(b). The IRS determined that Showalter failed to report business income, gambling winnings, and interest. The IRS issued a notice of deficiency assessing him a deficiency of a certain amount, plus addition to tax under sections 6651(a)(1) and (2), and 6654 of the I.R.C. Showalter contended the IRS’s deficiency arguing that the IRS did not consider his business expenses as deductions. He offered as evidence RECS’ bank account statements. IRS agreed that Showalter was entitled to certain deductions. However, the IRS determined that Showalter excluded other additional income regarding a real estate transaction from the analysis made to RECS bank statement. Showalter considered that the real estate income might be not subject to tax. The Tax Court analyzed all the evidence regarding the additional amount received by Showalter. The Tax Court determined the IRS correctly determined the additional unreported income for 2013.

Key Issues: Whether, Showalter has additional unreported income based on the deposits of RECS’ bank account?

Primary Holdings:  The Tax Court determined the IRS proved with the appropriate evidence “[t]hat its implementation of the bank deposits method was “reasonable in light of all surrounding facts and circumstances”.

Key Points of Law:

  • Under 26 U.S.C. § 61(a) gross income is all income from notwithstanding the source derived.
  • 26 U.S.C. § 6001 provides that a taxpayer must keep his books and records regarding his gross income.
  • The IRS may determine the taxpayer’s income, if he or she does not keep accurate accounting records in the opinion of the Secretary correctly reflects such income, under 26 U.S.C. 446(b). See Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989). “[T]he IRS has great latitude in reconstructing a taxpayer’s income, and the reconstruction “need only be reasonable in light of all surrounding facts and circumstances.” See Petzoldt, 92 T.C. at 687.
  • IRS may presume that the bank deposits in a taxpayer’s bank account during a given period are taxable income (Bank deposits method). See Price v. United States, 335 F.2d 671, 677 (5th Cir. 1964). The presumption is not applicable if the amounts are excluded taxable income, and “[t]he Government must take into account any non-taxable source . . . of which it has knowledge.” See DiLeo v. Commissioner, 96 T.C. 858, 868 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992).
  • Funds attributable to inter-account bank transfers and returned checks are non-taxable sources, additionally, “[l]oans, gifts, inheritances, or assets on hand at the beginning of the taxable period.” See Burgo v. Commissioner, 69 T.C. 729, 743 n.14 (1978)

Insights: A taxpayer challenging a deficiency of the IRS, must be aware that any evidence that it provides to the latter can be considered by the IRS to determine additional assessments to the taxpayer. Therefore, it is highly recommended that before providing any evidence in a tax procedure to determine if such documentation or information may create an additional tax burden for the taxpayers. At Freeman Law, we can gladly help you to analyze if that is the case.

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