03/30/2025
The more prepared you are in a tax audit to prove you are correct, as long as you follow the law, the higher your chances of success in the Tax Court. This is illustrated in T.C. Memo 2024-106. Here the taxpayer used a hybrid method of accounting in reporting revenue and expenses. When the IRS audited using a bank deposit analysis, the numbers did not agree. As the Court said:
"Bank deposits are prima facie evidence of income, and the IRS does not need to prove a likely source of income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); Estate of Mason v. Commissioner, 64 T.C. 651, 656–57 (1975), aff’d, 566 F.2d 2 (6th Cir. 1977). The bank deposits method assumes that all money deposited into a taxpayer’s bank account is taxable unless the taxpayer shows that the deposits are nontaxable or that he previously reported them as income. Clayton, 102 T.C. at 645–46; DiLeo v. Commissioner, 96 T.C. 858, 868 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992). However, the IRS must take into account any nontaxable sources of income that it has knowledge of. Price v. United States, 335 F.2d 671, 677 (5th Cir. 1964); DiLeo, 96 T.C. at 868. Once the IRS reconstructs a taxpayer’s income, the taxpayer bears the burden of proving that the IRS’s implementation of the bank deposits method is unfair or inaccurate. Clayton, 102 T.C. at 645–46."
In this case, the taxpayer had the accounting records detailed sufficiently to prove his system and how it correctly started income and was very credible during his testimony. This saved him a substantial amount of money in penalties. If you have questions about your taxes, contact ASK the Tax Guys, and we can help you.
