Tax Court addresses bank deposit method for reconstructing taxpayer income : 2013/06/27

In Kobel v. Commissioner, T.C. Memo. 2013-158, the United States Tax Court addressed the circumstances under which the IRS may use the bank deposit method for determining a taxpayer's income, and the taxpayer's burden to prove the analysis is inaccurate.  The Court explained that a taxpayer is required to maintain books and records establishing the amount of his or her gross income.  IRC section 6001.  If the taxpayer does not maintain such records, the IRS may use reasonable means to reconstruct the taxpayer's income.  When the IRS uses the bank deposit method, it will add all of the taxpayer's deposits for the tax year and assume every deposit is taxable income unless proven otherwise.  After the IRS has reconstructed the taxpayer's income and determined an income tax deficiency, the taxpayer has the burden of proving the bank deposit analysis is unfair or inaccurate.  This is a very difficult burden for a taxpayer that has failed to maintain adequate records.  What lessons should taxpayers learn from this case?  First, maintain adequate books and records.  Second, maintaining records of nontaxable deposits (gifts, loans, etc.) and expenses may be more important than maintaining records of taxable income.