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ACCT 446/570

Court Case Presentation

Key Points
Not a cut-and-paste exercise: If your documentation is mostly in the words of the court and the authorities cited by the courts, then you will not have demonstrated that you understand the case or that you can communicate in an appropriate manner. You will receive 0 points for that part of the assignment. Tone is for (aspiring) CPAs not attorneys: If you use the jargon that attorneys and judges are most familiar with, then you may have alienated your audience of accountants. Everyone must participate approximately equally in the presentation (and preferably in a sequential order): If your participation is too brief then you will not have demonstrated that you understand the case or that you can communicate in an appropriate manner. You will receive 0 points for that part of the assignment.

Organization of Summary Document


Court Case Citation
FACTS Taxpayer 1. Characteristics (type of entity, method of accounting, accounting period involved) 2. Tax base items involved (revenue or expenses) Government 1. IRS response to taxpayers treatment of tax base items 2. Court response (ruling) to IRS and taxpayer dispute (includes all rulings from original jurisdiction and appellate courts, but NOT the court case being reported on in this summary) ISSUES Identify each issue considered by the court in the appeals case being reported. Phrase it in terms of what the taxpayer should do or should have done, e.g., How much of the.income should the taxpayer have reported? AUTHORITIES Start with the most authoritative sources considered by the (appeals) court that you are reporting about: 1. IRC 2. IRR 3. Case precedent 4. Other You might arrange this process by issue, if there are multiple issues. CONCLUSION Provide a conclusion to each issue listed above. The conclusion comes first and any justification for the conclusion (i.e., the integration of the authorities) follows.

ACCT 446/570

Court Case Presentation

Unacceptable Cornell Jones was convicted as a drug dealer in Washington, D.C., in 1985. The IRS agents determined a tax deficiency and added additional assessments for failure to file and the substantial understatement of tax. The Tax Court ruled that the taxpayer had failed to report income related to the sale of illegal drugs and that the CIR had reconstructed the taxpayers income in a reasonable manner. The Tax Court did not agree with the CIRs determination of the additional assessments. The appellate court agreed with the Tax Court about the CIRs reconstruction of the income, but remanded the case back to the Tax Court for redetermination of the additional assessments.

Prescribed Cornell Jones was a cash basis, individual taxpayer who was arrested on October 29, 1985, and convicted as a drug dealer. He did not maintain any records of his income from the sale of cocaine and he did not file a 1985 U.S. individual income tax return (Form 1040).1 IRS agents reconstructed the taxpayers 1985 income using, in part, evidence and testimony provided by the police. They determined that the taxpayer had unreported income of $33 million for the first ten months of the tax year, prior to his arrest. As a consequence, the CIR issued a statutory notice of deficiency for $16 million in unpaid taxes and additions to that tax totaling $4.1 million for failure to file and a substantial understatement of income tax. The U.S. Tax Court (61 TCM 2379) upheld the Commissioner on the reconstruction of the income and the amount of tax due. The Tax Court disagreed, however, with the determination of the additional tax, due to a change in the penalty rate while the case was in process. 1. How much income from the sale of cocaine should the taxpayer have reported in 1985? 2. How much was the additional tax for the taxpayers failure to file? IRC 1 imposes a tax on the taxable income earned by an individual and 61 specifies that gross income includes all income from whatever source derived. This income tax is a self-reported tax and every taxpayer is required to file an annual tax return (6001) based on the method of accounting used to maintain the taxpayers accounting books (446(a)). A taxpayer also is subject to additions to his/her income tax liability under IRC sections 6651 (failure to file) and 6661 (substantial understatement of income tax). When a taxpayer fails to maintain adequate accounting records, the IRS can reconstruct the taxpayers income (Anson v. CIR, 13 AFTR 2d 858; Adamson v. CIR, 54 AFTR 2d 84-6115) by using any reasonable method, such as examining changes in the taxpayers assets or estimating income production. In that situation, it is the taxpayers burden to prove that the reconstruction is arbitrary and erroneous (Ruidoso Racing Assn, Inc. v. CIR, 31 AFTR 2d 73-1069). The taxpayer can meet that burden by proving that the IRS assessment is without foundation (United States v. Janis, 38 AFTR 2d 765378).

Whether the IRS properly determined the taxpayers taxable income for the year?

IRC 1 imposes a tax on the taxable income earned by an individual. 61 specifies that gross income includes all income from whatever source derived. 6001requires every taxpayer to file an annual tax return. 446(a) allows a taxpayer to maintain his/her tax accounting records based on the method of accounting used to maintain the taxpayers accounting books. IRC sections 6651 and 6661 impose additions to a taxpayers income tax liability for failure to file and substantial understatement of income tax, respectively. In Anson vs. CIR, the CIRs authority to reconstruct a taxpayers income was established. When he does so, it was ruled in Ruidoso Racing Assn, Inc. v CIR that the burden was on the taxpayer to prove that the CIR acted arbitrarily and capriciously and that his reconstruction was unfounded (U.S. v. Janis, 38 AFTR 2d 76-5378, 96 S. Ct. 3021, 76-2 USTC 16,229).

ACCT 446/570

Court Case Presentation

The criminal case proved that the taxpayer was in the business of selling cocaine. In the tax case it was proven that he failed to maintain adequate accounting records and to report the income from that business in a timely filed 1985 individual income tax return. Given the CIRs reconstruction of his income, the taxpayer should have reported $33 million of income from the sale of cocaine in that year and incurred an additional tax for not filing the tax return and substantially understating his tax liability. The taxpayer failed to provide evidence to establish that the Commissioners estimate of his income was incorrect. The Tax Court erroneously omitted and miscalculated the additions to the tax, so its ruling was reversed and the case was remanded to it for recalculation of the additions.

The taxpayer should have reported $33 million of income from the sale of cocaine in 1985 and incurred an additional tax based for not filing the tax return and substantially understating his tax liability. The taxpayer failed to provide evidence to establish that the Commissioners estimate of his income was incorrect. The Tax Court erroneously omitted and miscalculated the additions to the tax, so its ruling was reversed and the case was remanded to it for recalculation of the additions.

Summary Organization and Content Checklist


Yes Facts Taxpayer Action Entity Method of accounting (if available) Tax period of dispute Item and amount of tax base in dispute Government Reaction IRS Court of original jurisdiction Appellate court(s) Issues (in terms of what the taxpayer should (should not) have done) N/A

Authorities (as identified by the court in the case being presented) IRC and IRR relevant to the issues Case precedents relevant to the issues

Conclusion (of the court) Ruling on the issues Justification for the ruling