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Business Recordkeeping
Lost Records Open Door for IRS
Irving, TC Memo 2006-169
When taxpayers can’t substantiate income and expenses, the IRS can use the bank
deposits method, which assumes that all deposits are taxable, to compute
taxable income.
Facts. The Irvings, husband and wife, filed tax returns for 200 and 2001
reporting the net profit from their business on Schedule C. They used a
computer to keep their business records, with both paper and electronic copies.
In 2003, the returns were audited. By the time the audit began, the Irvings had
destroyed the paper records, since they had shut down the business. They were
unable to produce any electronic records due to a computer malfunction.
IRS position. The IRS agent used the bank deposits method to reconstruct
the Irvings’ revenue and expenses. In doing so, he determined they had
significantly understated receipts and overstated deductions.
Court’s ruling. The Court rules for the IRS, dismissing the taxpayers’
argument that, because they maintained records, Section 7491 shifts the burden
of proof to the IRS. The Court said that Section 7491would only shift the
burden of proof if the taxpayers could actually present records of their
business receipts and expenses, which they couldn’t. Using the bank deposits
reconstruction method was an appropriate way for the IRS to determine taxable
income, since the Irvings could produce no evidence that the expenses
disallowed by the IRS were deductible, or the receipts nontaxable. The cost to
the Irvings was additional tax of $75, 565.
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