Individual’s Income Reconstructed Using Bank Deposits Method

An individual had unreported Schedule C gross receipts for one out of three tax years at issue. He was the sole member of a limited liability company (LLC) that later converted to a corporation. He had signatory authority over these entities’ bank accounts, made deposits into these accounts and used them to defray his personal expenses.

Income Reconstructed Using Bank Deposits Method

The taxpayer failed to maintain any records to establish the amount of gross income. Thus, the IRS used the bank deposits method to reconstruct his income. The IRS also established that his corporation did not have a separate legal existence. It was not formed for a business purpose and it did not carry on a business activity. Therefore, the taxpayer had to include the corporate deposits in his own gross receipts.

Deductions Disallowed

Moreover, the taxpayer could not deduct certain ordinary and necessary business expenses because he failed to meet the strict substantiation requirements. Specifically, he was not entitled to deductions for

  • automobile expenses for two tax years, and
  • travel expenses for one tax year.

He failed to provide contemporaneous mileage or travel logs to substantiate the time, place or business purpose of these expenses.

In addition, the taxpayer could not deduct home office expenses in excess of amounts the IRS allowed. He failed to produce any records to substantiate his:

  • mortgage interest,
  • real estate taxes
  • utilities, or
  • management fees.

Also, the taxpayer could not deduct a commission expense. He failed to substantiate the amount or business purpose of the expense. He also failed to provide a basis to estimate the expense.

Accuracy-Related and Delinquency Penalties

Further, the taxpayer was liable for an accuracy-related penalty because of his negligence and disregard of rules and regulations. Alternatively, he was liable on the basis of substantial understatements of income tax. The taxpayer’s argument, that his unreported gross receipts should have been reported on a corporate tax as nontaxable equity, was rejected. He failed to establish that he made a reasonable effort to assess his proper tax liabilities.

Finally, the taxpayer was liable for additions to tax for two tax years. The taxpayer filed his returns three days after their due dates under extension. He did not provide any explanation for his late filings or establish that the late filing was due to reasonable cause and not willful neglect.

D. Imperato, TC Memo. 2018-126, Dec. 61,238(M)

Login to read more tax news on CCH® AnswerConnect or CCH® Intelliconnect®.

Not a subscriber? Sign up for a free trial or contact us for a representative.



All stories by: CCHTaxGroup