Mason v. Commissioner, 54 T. C. 1364 (1970)

When a taxpayer fails to keep adequate records, the burden of proof shifts to them to disprove the Commissioner’s determination of income using the bank deposit method.

Summary

In Mason v. Commissioner, the Tax Court upheld the use of the bank deposit method to determine the taxpayer’s unreported income for 1966 and 1967. The taxpayers, Robert and Mary Mason, did not maintain adequate records, leading the Commissioner to use bank deposits as evidence of income. The court ruled that the burden of proof to disprove this determination was on the Masons. The court found that while some deposits were not income due to check kiting and transfers, the Masons had substantial unreported income. Additionally, the court upheld the negligence penalty due to the Masons’ failure to keep proper records and report their income accurately.

Facts

Robert and Mary Mason filed joint tax returns for 1966 and 1967, reporting minimal income from interest and rentals. During an audit, it was discovered that they had made significant bank deposits during those years, totaling over $157,000 in 1966 and over $623,000 in 1967. Robert Mason claimed these deposits resulted from check kiting and cashing checks for others, but he provided no documentation to support his claims. The Masons failed to maintain any records, and after Robert Mason’s initial unconvincing explanations, the Commissioner used the bank deposit method to determine their income.

Procedural History

The Commissioner assessed deficiencies and negligence penalties against the Masons for the tax years 1966 and 1967. The case was brought before the U. S. Tax Court, where the Masons challenged the Commissioner’s determinations. The Tax Court upheld the use of the bank deposit method and found that the Masons had unreported income and were liable for negligence penalties.

Issue(s)

1. Whether the burden of proving the petitioners’ gross income for 1966 and 1967 is on the Commissioner.
2. What income the petitioners actually received in 1966 and 1967.
3. Whether any part of the underpayment of the petitioners’ tax for 1966 and 1967 was due to negligence or intentional disregard of rules and regulations.

Holding

1. No, because the taxpayer’s failure to maintain adequate records shifts the burden of proof to them to disprove the Commissioner’s determination of income.
2. The petitioners had unreported income of $51,422. 09 in 1966 and $84,954. 37 in 1967, as the court found that the bank deposits, after accounting for transfers and kited checks, represented income.
3. Yes, because the petitioners’ failure to keep records and report their income accurately constitutes negligence or intentional disregard of rules and regulations.

Court’s Reasoning

The court applied the well-established rule that bank deposits are prima facie evidence of income when a taxpayer fails to maintain adequate records. The Masons did not provide credible evidence to rebut this presumption, and their claims of check kiting and cashing checks for others were not supported by specific evidence. The court noted that the Commissioner’s use of the bank deposit method was not arbitrary, given the Masons’ lack of cooperation and records. The court also considered the testimony of witnesses, but found it insufficient to overcome the presumption of income from the deposits. The court rejected the Masons’ arguments that the Commissioner should have used the net worth method, citing the validity of the bank deposit method in this context. Finally, the court upheld the negligence penalties, as the Masons failed to meet their burden of proof on this issue.

Practical Implications

This case reinforces the importance of maintaining accurate records for tax purposes. Taxpayers who fail to do so risk having their income determined by the bank deposit method, with the burden of proof to disprove this determination falling on them. Practitioners should advise clients to keep detailed records of all financial transactions, especially those involving large deposits, to avoid similar outcomes. The decision also highlights the need for cooperation with tax audits, as the Masons’ lack of cooperation contributed to the court’s ruling. Subsequent cases have cited Mason v. Commissioner in upholding the use of the bank deposit method and the shift in burden of proof to the taxpayer when records are inadequate.