Lack of Adequate Records by Taxpayer Not a Deterrent to Preventing IRS from Reconstructing Taxable Income
Francis Steffan Hayes [T.C. Memo 2019-147] failed to file his tax returns for years 2005-2009 and paid no taxes during that time span. He claimed that he did not maintain adequate records, refused to cooperate with the IRS, and would not present any records to assist the IRS in its audit.
IRS Audit Steps to Reconstruct Income
To reconstruct his income, the IRS (1) summoned accounts in his name at Wells Fargo, PayPal and e-gold; (2) contacted his customers and vendors to determine his gross receipts; and (3) searched for income that he may had deposited elsewhere.
The IRS also included in his unreported income checks and money orders found in the accounts of two of his friends. Most of these checks had been addressed to Mr. Hayes or one of his business enterprises which he had endorsed over to his friends. Since Hayes had unfettered use of these funds when received, they were considered taxable to him. When customer records were subpoenaed, the IRS discovered checks written to Hayes which the IRS included as taxable income to him. The revenue agent who conducted the examination then turned his findings to another IRS revenue agent who prepared substitute for returns for Hayes.
IRS Evidentiary Matter
Gross income includes all income from whatever source derived [IRC Sec. 61(a)]. IRC Sec. 6001 states that taxpayers must keep adequate books and records from which their correct tax liabilities can be determined. When a taxpayer fails to keep records, the IRS has discretion to reconstruct the taxpayer’s income by any reasonable means [IRC Sec. 446(b)].
The IRS was able to demonstrate to the court with its documentation that it had taken the necessary evidentiary steps to reconstruct Hayes’ income and allowing him certain expenses. At this point, the burden of proof shifts to Hayes to prove (by a preponderance of the evidence) that the IRS’ determinations are arbitrary or erroneous.
Taxpayer’s Arguments Before the Court
Hayes represented himself in court and argued various variations on oft-rejected tax-defiance themes and that the returns prepared by the IRS were invalid.
Tax Court’s Findings
The court found in favor of the IRS. It stated that the taxpayer offered only meritless arguments against the IRS’ imposition of additions to tax and failed to show any reasonable cause.
Tax Planning Tip #1:
The best and easiest way to prevail in an IRS audit exam is to have substantiation for the income and expenses shown in your return.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.