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Respondent’s Determination of Omitted Income for 1996
Respondent first examined petitioners’ 1996 tax return.
Respondent allowed the claimed advertising expense with respect
to Mr. Possas’s activity; however, respondent disallowed the
claimed expenses relating to the hairdressing activity.
Respondent also reconstructed petitioners’ income and prepared a
bank deposit analysis. The examiner totaled the deposits made in
1996 into each of petitioners’ bank accounts and then traced
these deposits to known sources of income, such as wages reported
on the return and Forms W-2, Wage and Tax Statement, prizes and
awards, redeposited liquidated certificates of deposit (CDs), and
transfers between accounts. Respondent assumed that the
unexplained deposits were the gross receipts from Mrs. Possas’s
hairdressing activity.
The examiner concluded that petitioners were “entitled to
some form of expense, because you cannot be a beautician without
having to spend something”. The examiner used statistics from
the Bureau of Labor Statistics (BLS) to calculate the “profit
margin” for a beautician using a “gross profit percentage”, which
was 65 percent, and applied this profit margin to the
reconstructed gross receipts.3 This application resulted in
3 Respondent used figures for beauticians available from
the Bureau of Labor Statistics from a document entitled “Sole
Proprietorship Returns from 1994”. The figures are for net
income and take average industry expenses into consideration.
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Last modified: May 25, 2011