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respondent used an understated amount of cash on hand in the
calculation of petitioners’ business income. A larger amount of
cash on hand would reduce respondent’s income determination under
the source and application of funds method.
Taxpayers are required to keep adequate records with which
the Commissioner may determine their correct tax liability. See
sec. 6001; sec. 1.6001-1(a), (d), Income Tax Regs. In the
absence of such adequate records, the Commissioner may
reconstruct income using a method that clearly reflects income.
See Cebollero v. Commissioner, 967 F.2d 986, 989 (4th Cir. 1992),
affg. T.C. Memo. 1990-618; Petzoldt v. Commissioner, 92 T.C. 661,
687 (1989). The Commissioner may use indirect methods to
reconstruct income, so long as they are reasonable in the
circumstances. See Holland v. United States, 348 U.S. 121, 126
(1954); Giddio v. Commissioner, 54 T.C. 1530, 1532-1533 (1970).
Respondent reconstructed petitioners’ income using the
source and application of funds method. Petitioners do not
question respondent’s use of the source and application of funds
method for reconstructing their income. Petitioners argue,
however, that respondent’s determination of their income was
overstated because respondent used too small an amount of cash on
hand in the computation. Petitioners do not question other
aspects of respondent’s calculations. Accordingly, we must
consider whether respondent erred in the reconstruction of
petitioners’ income only with respect to the amount of cash
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