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121, 131-132 (1954); Erickson v. Commissioner, 937 F.2d 1548,
1552-1553 (10th Cir. 1991), affg. T.C. Memo. 1989-552; Giddio v.
Commissioner, 54 T.C. 1530, 1532-1533 (1970).
The source and application of funds method (also sometimes
referred to as the expenditures method) is an accepted indirect
method of reconstructing income. See, e.g., Williams v.
Commissioner, 999 F.2d 760, 763 (4th Cir. 1993), affg. T.C. Memo.
1992-153. Under that method, any amount by which the taxpayer's
total application of funds during the taxable year exceeds the
total funds available to him from known sources for that year is
attributed to unreported taxable income absent some showing by
the taxpayer of a nontaxable source. See, e.g., id., Troncelliti
v. Commissioner, T.C. Memo. 1971-72 (“As explanation the taxpayer
may show that the difference between the total application [of]
funds and the total reported sources of funds is attributable to
such nontaxable items as loans, gifts, inheritances, or assets on
hand at the beginning of the taxable period.”). Thus, as part of
the reconstruction of income using the source and application of
funds method, respondent must exclude funds that the taxpayer had
accumulated before the first taxable year under examination
insofar as those funds are a source of subsequent expenditures.
See Flood v. Commissioner, T.C. Memo. 2001-39. Frank and
Katherine dealt primarily in cash and provided to respondent no
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