Tax Court in Brief | Degourville v. Comm’r | Earned Income Tax Credit, Head of Household Status, and “Badges of Fraud”

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Tax Litigation:  The Week of September 12th, 2022, through September 16th, 2022

Degourville v. Comm’r, T.C. Memo. 2022-93 | September 12, 2022 | Wells, J. | Dkt. No. 4369-16


Short Summary:  During the 2012 tax year, petitioner was married and resided in the same household with her husband. Petitioner solely owned and operated two businesses directly— a hair salon and a tax preparation business—and she and her husband jointly owned a restaurant. Petitioner and her husband kept bank accounts to manage cashflow from each of these businesses.

In 2012 and 2013, petitioner used cash to purchase four properties in Georgia for $23,000, $20,000, $52,000, and $90,000 respectively. On this last property, petitioner and her husband later paid $366,436 by personal and cashier’s checks for the construction of a home. Between 2010 and 2013, petition also used cash to purchase five automobiles and a motorcycle.

In 2014, the Internal Revenue Service (“IRS”) assessed a return preparer earned income tax credit (“EITC”) due diligence penalty of $45,000 for the 2012 taxable year under I.R.C. § 6695(g).

In 2016, the State of Georgia convicted petitioner of one count of state tax evasion (for failing to report income on her state individual income tax return) and one count of theft by taking (for improperly filing her tax preparation clients’ state income tax returns). At her state criminal trial, petitioner testified that her tax preparation business generated $552,865 in gross receipts in 2012 and that $168,466 of these gross receipts was reported as profit on her amended state income tax return for that year. She also testified that her hair salon generated $150,000 in revenues in 2012 and that her and her husband’s restaurant incurred a substantial loss that year.

Petitioner and her husband each separately filed their own Form 1040, U.S. Individual Income Tax Return, for 2012 electing the head of household filing status. Petitioner later conceded that the address she listed on the return was where her mother lived. Petitioner and her husband also each claimed the EITC for 2012 on their respective returns. In the two Schedules C, Profit of Loss from Business, attached to petitioner’s return, petitioner reported gross receipts of $20,316 for her hair salon and $15,811 for her tax preparation business. On these Schedules C, petitioner claimed various deductions, including $18,300 in rent/lease expenses for the hair salon and $5,000 in commission expenses for the tax preparation, resulting in reported net profits of $980 for the hair salon and $9,088 for the tax preparation business.

The IRS began an examination of petitioner’s 2012 return and requested that petitioner produce records of her income-producing activities in that year. Petitioner failed to provide such records, claiming that they were being held by Georgia state authorities as part of the state’s criminal investigation. In the absence of these records, the IRS conducted a bank deposit analyses on the bank accounts that petitioner held with her husband in order to determine petitioner’s 2012 adjusted gross income. These analyses showed that $1,054,255 was deposited into these bank accounts in 2012, of which $911,033 were unexplained. Based on this information, and after taking into account properly allowed business expenses and computational adjustments, the IRS determined that petitioner had unreported gross receipts of $439,705. The IRS also adjusted petitioner’s filing status from head of household to married filing separately, disallowed petitioner’s claim to the EITC, disallowed the lease/rent expenses claimed for the hair salon and the commission expenses claimed for the tax preparation business, and asserted the civil fraud penalty against petitioner.

Key Issues

Primary Holdings

Key Points of Law

Insights: This case provides a good illustration of the analysis that the Tax Court uses in determining whether the civil fraud penalty should be imposed. In particular, the Tax Court’s analysis shows the type of evidence that may be persuasive in establishing certain “badges of fraud” indicating fraudulent intent on the part of a taxpayer.