Brendt L. Smith - Page 9

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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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