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Respondent used the source and application of funds method
to reconstruct petitioner’s income.8 Respondent’s analysis
showed that the excess of petitioner’s application of funds over
his known sources of income in 1995 was $64,327, as compared to
reported gross receipts of $12,652. Respondent’s analysis showed
that the excess of petitioner’s application of funds over his
known sources of income in 1996 was $40,562, as compared to
reported gross receipts of $37,311.
In addition, respondent adduced evidence at trial that
establishes the following.
An agent of respondent conducted an examination of
petitioner’s 1995 and 1996 taxable years. At the time of the
examination, petitioner had conducted a construction business for
at least 9 years, which served as his primary source of income.
While petitioner was able to substantiate some expenses of
his income-producing activities in 1995 and 1996, he failed to
maintain or submit for examination by respondent books and
8 The source and application of funds method of proof has
been accepted by this Court as an appropriate method for the
Commissioner to reconstruct the income of a taxpayer whose
records are inadequate. See, e.g., DeVenney v. Commissioner, 85
T.C. 927 (1985). The Court of Appeals for the Seventh Circuit,
to which an appeal in this case lies barring stipulation to the
contrary, has likewise upheld the cash expenditures method, a
reconstruction method very similar to the source and application
of funds method. See, e.g., United States v. Marrinson, 832 F.2d
1465, 1469-1470 (7th Cir. 1987); cf. Hall v. Commissioner, T.C.
Memo. 1996-27 (discussing distinction between cash expenditures
and source and application of funds methods).
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