In the case of Kahmann v. Commissioner, TC Summary Opinion 2017-35 the IRS was suspicious that the taxpayers had understated their gross income from their business for the year. Some of this suspicion arose because the taxpayers failed to turn over bank statements for the business to the agent when they were requested.

The agent was forced to issue summonses to banks where she was aware the taxpayers maintained at least three accounts. She obtained those accounts to be able to perform a bank deposits analysis, looking for unreported income.

The presumption exists that amounts deposited into a bank account represent income. The IRS does have to remove any deposits that the agency becomes aware are not income (such as bank transfers). At that point, the burden generally shifts to the taxpayer to provide evidence to show that any other deposits were also not taxable income. To the extent the taxpayer does not produce such evidence the amounts are considered income.

In addition to the bank deposits analysis, the agent also had in her possession two Forms 1099K issued in the name of the taxpayers’ business and were mailed to the address shown on the couple’s income tax return for the year under examination.

When the agent concluded the bank deposits analysis she identified the following classes of deposits:

$375.15 from Amazon
$134,318.27 from bank card deposits
$4,864.77 from checks made payable to the taxpayer’s business
$24,875 from cash deposits and
$5,169.85 from ATM deposits

These amounts totaled $169,603.04, substantially more than the gross receipts reported on the Schedule C that year of $128,070. But the agent also noticed that the two Forms 1099K totaled $151,835.06, or over $17,000 more than she was able to find deposited from credit cards on the bank statements. As well, she found that she could not reconcile many of the deposits made through the credit card processor. She believed the reason for this was the taxpayers had other bank accounts they had not informed her about.

For this reason, she substituted the Form 1099K totals for the credit card deposits in her analysis and used this gross revenue as the business’s actual revenue.

IRC §6201(d) provides taxpayers with some protection against the IRS relying on information returns, including the Form 1099Ks in this case. If the conditions are fulfilled, the burden shifts to the IRS to provide “reasonable and probative information” in addition to the information return.

In this case, the taxpayers failed to meet the condition that is required to trigger this protective provision that shifts the burden on the IRS to go beyond the Form 1099K—the taxpayer must fully cooperate with the IRS in the exam. In this case, the taxpayers’ failure to produce the bank statements when requested, forcing the IRS to issue summonses for them. As well, despite arguing that some of the income on the Forms 1099K represented income of his brother, he did make his brother available at trial nor to the IRS prior to trial, rather only presenting letters he indicated were written by his brothers. Such actions fell well short of “fully cooperating” with the IRS, as §6201(d) requires the taxpayer provide timely “access to and inspection of all witnesses, information, and documents within the control of the taxpayer as reasonably requested by the Secretary”.

The taxpayer did list a litany of reasons why he claimed large parts of the amounts the agent showed as income were not really income. The reasons included:

A claim the cash deposits came from a large cash hoard the taxpayers had on hand at the beginning of the year;
The check deposits represented income of his brother, whom he claimed also operated a business with the same name;
The unaccounted for credit card charges were “really” also his brother’s income, as he allowed his brother to use the machine for his business

However, the taxpayer did not introduce evidence beyond his own statements and the letters he claimed were from his brothers to support his own assertions for these issues.

The Court noted that the Court has often heard the “cash hoard” claim and that it has almost never worked. The Court was not presented with plausible evidence, aside from the taxpayer’s own claims, that the hoard existed or that it arose from inheritances and gifts from family members. The Court determined this fell far short of being evidence the “cash hoard” was actually the source of those deposits.

The Court also found the letters to be inadmissible hearsay since he did not produce his brothers to testify in the case to back him up. He provided no evidence, aside from his testimony, that his brothers had operated a business during the year in question. So, again, the Court refused to remove either the check deposits or the “extra” credit charges from income.

The taxpayer did produce a handwritten ledger of sorts that he claimed had been produced as the goods were sold. The Court did not find that testimony credible, noting that the entries were all written in the same handwriting and with the same shade of ink, making it far more plausible the entries were made all at one time rather than made at the time of each sale. As well, the taxpayers could not reconcile that handwritten schedule to the bank deposits.

In the end the Court agreed with the IRS’s view that the taxpayer had significant unreported income, and accepted the IRS’s reconstruction of income based on the bank deposits analysis and the Forms 1099K