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books and records relating to Katherine’s palmistry business.19
Under the circumstances, respondent’s use of the source and
application of funds method to reconstruct Frank and Katherine’s
income for the years in issue was reasonable.
Where the allegation of fraud is intertwined with unreported
and indirectly reconstructed income, respondent can satisfy the
burden of proving an underpayment of tax in one of two ways. See
Parks v. Commissioner, 94 T.C. 654, 661 (1990). First,
respondent may prove a likely source of the unreported income;
second, where the taxpayer alleges a nontaxable source for the
funds, respondent may prove that the nontaxable source did not
exist. See id.
(1) Likely Sources of Income
Respondent contends that Katherine’s palmistry business was
a likely source for the unreported income. Respondent also
contends that unreported gambling winnings were another likely
source. Additionally, respondent contends that Frank may have
unreported income from work as a real estate broker as he alleged
in certain loan applications.20
19 Although there is testimonial evidence that Katherine
made some recordations of income on tablets that she kept for
that purpose, there is no evidence that those tablets were
submitted to respondent, nor were they introduced at trial.
20 We made no findings of fact relating to the loan
applications because we find that the statements contained
therein lack trustworthiness.
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