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Taxpayers are required to maintain records sufficient to
establish the amounts of income, deductions, and other items
which underlie their Federal income tax liabilities. Sec. 6001;
sec. 1.6001-1(a), (e), Income Tax Regs. If a taxpayer fails to
keep adequate records, the Commissioner may reconstruct the
taxpayer’s income by any method that is reasonable under the
circumstances. Petzoldt v. Commissioner, 92 T.C. 661, 687
(1989); see also United States v. Fior D’Italia, Inc., 536 U.S.
238, 243 (2002) (stating that the assessment authority of the IRS
is not exceeded “when the IRS estimates an individual’s tax
liability--as long as the method used to make the estimate is a
‘reasonable’ one”). The reconstruction need not be exact, so
long as it is reasonable and substantially correct. Petzoldt v.
Commissioner, supra at 693; Meneguzzo v. Commissioner, 43 T.C.
824 (1965). The bank deposit and cash expenditure method is
recognized as a reasonable method of reconstructing income.
Parks v. Commissioner, 94 T.C. 654, 658 (1990); Nicholas v.
Commissioner, 70 T.C. 1057, 1065 (1978). This method is premised
on the assumption that the taxpayer has disposed of unreported
income by depositing part of it into bank accounts and by making
cash expenditures of the other part.
2(...continued)
164(f)(1) self-employment income tax deduction was not applicable
in 1989. Social Security Amendments of 1983, Pub. L. 98-21, sec.
124(d)(2), 97 Stat. 91.
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