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ESSEL EYEWEAR, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, T.C. Memo. 2024-11
During 2018 and 2019 petitioner engaged in the business of selling eyewear at wholesale. It filed timely returns for both years on Form 1120, U.S. Corporation Income Tax Return. To verify the gross receipts reported on these returns, Revenue Agent summonsed the bank records of petitioner and its sole shareholder. For 2018 she determined that an $11,000 business receipt belonging to petitioner had been deposited into the shareholder’s account and was excluded improperly from petitioner’s gross receipts. For 2019 she determined that petitioner’s bank account had unexplained deposits of $25,894 that should have been included in its gross receipts. She provided her bank deposits analysis to petitioner and its representative. Neither presented any evidence that the $36,894 (or any portion thereof) derived from nontaxable sources or was otherwise excludable from petitioner’s gross income.
To verify petitioner’s reported cost of goods sold (COGS) and business expense deductions, Revenue Agent requested substantiation from taxpayer. The taxpayer supplied documents in several phases during 2021, and the Revenue Agent revised their findings, accordingly, determining the taxpayer had substantiated only a portion of its reported COGS, advertising expenses, and “other” deductions for 2018 and 2019 and it had substantiated none of a $2,000 bad debt deduction claimed for 2019. On the other hand, the Revenue Agent concluded the taxpayer should be allowed an additional deduction of $6,500 for each year for rental expenses.
The Revenue Agent prepared and forwarded to their manager for approval a draft 30-day letter setting forth the proposed adjustments, including a civil penalty approval form recommending a 20% accuracy-related penalty be asserted for each year. The manager returned the package, approving the 20% penalties for substantial understatements of income tax (or alternatively for negligence). The Revenue Agent forwarded the draft report to the taxpayer and representative and revised it after receiving additional information.
The Revenue Agent sent the final report to the taxpayer and their representative with no further communication, and the examination was closed. The taxpayer appealed the findings to the IRS Independent Office of Appeals without any relevant information to the Appeals Officer in their response, so it went to Tax Court.
After numerous attempts with no response from the taxpayer for the reason to dispute the Revenue Agent’s final approved examination, no material facts are in dispute. The Revenue Agent reconstructed petitioner’s income using the bank deposits method. Taxpayers must maintain books and records sufficient to establish their income and expenses. When a taxpayer fails to do so, the Commissioner may reconstruct its income by examining its bank deposits. Bank deposits are evidence of income, and the Commissioner need not show a likely source of the revenue. We presume that all money deposited into a taxpayer’s account is taxable unless the taxpayer shows that particular deposits are nontaxable or were previously reported as income. Petitioner provided no evidence that these deposits reflected nontaxable items or that her analysis was incorrect in any respect.
Accuracy-Related Penalties
Petitioner reported tax liabilities of $6,356 and $4,262, respectively, on its returns for 2018 and 2019. The notice of deficiency—the adjustments in which we have sustained—determined tax liabilities of $53,202 and $28,056, respectively. This leaves understatements of $46,846 for 2018 – $6,356 penalty ($53,202 total) and $23,794 for 2019 – $4,262 penalty ($28,056 total). Petitioner has supplied no evidence to establish reasonable cause or good faith. By failing to respond to the Second Request for Admissions, petitioner is deemed to have admitted that it “is liable for the substantial understatement penalty . . . in the amounts determined in the statutory notice of deficiency.”