T.C. M em o . 2 0 1 7 -1 2 4
UNITED STATES TAX COURT
RICHARD A. CANATELLA, Pet i t i o n er v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 9 3 75 -1 3
. Fi l edJ u n e 2 6 , 2 0 1 7
.
Ri ch ardA. Can at el l a, fo r h i m s el f. L. Katri n e Sh el t o n , Bren n C. Bo u wh u is , an dCh arl es B. Bu rn et t , fo r
res p o n d en t.

M EM ORANDUM FINDINGS OF FACT AND OPINION
M ORRISON, J u d g e: Th e res p o nd en t (referred t o h ere as th e “ IRS”) i s s u ed
a n o t i ce o f d efi ci en cy

t o the p et i t i o n er, Ri ch ard A. Can at el l a, fo r t h e t ax ab l e y ears 2 0 0 8 , 2 0 0 9 , an d 2 0 1 0. Th e IRS d et erm i n edt ax d efi ci en ci es o f $ 2 4 8,2 6 2 fo r 2 0 0 8 , $ 9 2 ,7 5 8 fo r 2 0 0 9 , an d $ 1 28 ,1 6 7 fo r 2 0 1 0 , an daccu racy -rel at edp en al t ies u n d er- 2
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[* 2 ] s ect i o n 6 6 6 2(a) o f $ 4 9 ,6 5 2 fo r 2 0 08 , $ 18 ,5 5 2 fo r 2 0 09 , an d$ 2 5 , 6 3 3 fo r 2 0 1 0
. 1 Can at el l a t i m el y fi l eda p et i t io n u n d er s ect i o n 6 2 1 3 (a) fo r red et erm i n at io n
o f t h e d efi ci en ci es . 2 W e h av e juri s d ict i o n u n d er s ect i on 6 2 1 4. In th is o p i ni o n we h o l d : 1
. Th e Co u rtd i d n o terr i n al l o wi n g th e rev en u e ag en tt o rem ai n i n th e
co u rtro o m

aft er Can at el l a’ s req u es tt o ex cl u d e fact wi tn es s es fro m th e co u rt ro o m atthe b eg i nn in g o f t ri al . See i n fra p art1
. 2
. Th e co u n s el fo r t h e IRS d i dn oten g ag e i n m i s co n du ctdu e t o th e
m i s l ab el i n g o f ex h i b i t s. See i n fra p art2
. 3
. Th e IRS’ s b an k-d ep o s i t s an al y s i s i s n oterro n eo u s as a wh ol e. Ho wev er, $ 1 2 4,0 0 0 i n d ep o s i t s were i m p ro perl y ch aract eri zedas i nco m e t o Can at el l a fo r 2 0 0 8 . See i n fra p art3
. FINDINGS OF FACT So m e o f t h e fact s h av e b een s ti p u lat ed an dare s o fo u n d.

1 Un l es s o th erwi s e i nd i cat ed , al l s ect i o n referen ces are t o s ect i o n s o f th e In t ern al Rev enu e Co d e as i n effect fo r th e y ears at i s su e, 2 0 0 8-2 0 1 0 , an dal l Ru l e referen ces are t o th e Tax Co u rtRu l es o f Pract i ce an dPro cedu re. Al l d ol l ar am ou n t s are ro u n dedt o t h e n eares td o l l ar.

2 Can at el l a was a res i d en t o f Cal i fo rn i a wh en h e fi ledth e p et i t i o n. Th erefo re, an ap p eal o f o ur d eci s i o n i n th i s cas e wo u l d g o t o th e U.S. Co u rto f Ap p eal s fo r t h e Ni n th Ci rcu i t, s ee s ec. 7 48 2 (b )(1 ), un l es s th e p art i es d es i g nat e t he Co u rto f Ap p eal s fo r an o th er ci rcu i t , s ee i d . p ara. (2 ).- 3
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[* 3 ] I. Back g ro u n d In 2 0 0 8 -1 0 , Can at el l a o p erat ed a l aw fi rm d o i n g b u s i n es s as Co t t er & Del Carl o . He was th e o n ly

l awy er i n th e fi rm , wh i ch o p erat ed as a s o l e p ro p ri et ors h i p . Befo re i t s wi n d i n g up o f b u s i nes s i n 2 01 0 , th e fi rm h adb een i n
ex i s t en ce o v er 4 0 y ears an ds p eci al i zedi n p ro b at e m at ters . As a res u l t o f l i t i gat i o n o r s et t l em en t s , Can at el l a o ft en recei v edfu n ds p ay ab l e t o h i s cl i en t s an dwas o b l i g at ed t o h o l dthe fu n d s i n t ru s tu n t il d i s tri b u t i o n s were warran ted . Fro m 2 0 0 8 t o 2 0 1 0 , Can at el l a m ai n t ai ned2 0 b an k
acco u n t s ats ix fi n an ci al i ns t itu t i o n s. II. Tax Rep o rt i n g ; N ot i ce o f Defi ci en cy Can at el la fi l edl at e Fo rm s 1 0 4 0 , “ U.S. In d i v i du al In co m e Tax Return ”, fo r 2 0 0 8 , 2 0 0 9 , an d 2 0 1 0. Can at el l a fi ledb o th h i s 2 00 8 an d2 0 0 9 retu rn s o n J u n e 1 0 , 2 0 1 1 , an dh i s 2 0 1 0 retu rn o n No v em b er 4 , 2 0 11
. Du ri n g each o f t h e t h ree y ears , Can at el l a fi l ed u n d er t h e s t atu s o f m arri ed
fi li n g -s ep arat el y . Anacco u n t an tp rep ared each o f t h e ret u rn s . Onh i s retu rn s fo r 2 0 0 8 , 2 0 0 9 , an d 2 0 1 0, Can at el la d i dn otrep ortan y i n co m e o th er t h an the b u s i n es s i n co m e th ath e rep o rt edo n h is Sch edu l es C, “ Pro fi to r Lo s s Fro m Bu s i n es s ”. Th e Sch edu l es C rep o rt edth e fo l l o wi n g b u s i nes s i n co m e, ex p en s es (b ro k en d o wni n t o
v ari o u s cat eg o ri es ), an dg ai n / l o s s fro m th e o p erat i o n o f Co t t er & Del Carl o :- 4
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[* 4 ] 2 0 0 8 2 0 0 9 2 0 1 0 Gro s s recei p ts $ 5 0 9 , 4 8 6 $ 3 8 2 ,3 7 2 $ 17 0 ,6 5 4 Ex p en s es 4 3 6 , 0 9 6 3 1 1 ,1 3 0 2 1 0,8 5 1 Net p ro fi t/ l o s s 7 3 , 3 9 0 7 1 ,2 4 2 (4 0,1 9 7 ) Ev en tho u g h Can at el l a rep o rt edo nl y b u s i nes s i n co m e o n h i s t ax retu rn s , th e IRS recei v edi nfo rm at i o n ret u rn s fro m p ay o rs s h o wi n g th atth ey p ai dCan at el l a i n t eres tan dSo ci al Secu ri ty i n co m e. Th e IRS i n i t i at edan au d i to f t h e 2 0 0 8 , 2 0 0 9 , an d 2 0 1 0 retu rn s o n acco un to f b o th h i s fai l u re t o t i m el y fi l e t h es e ret u rn s an dh i s fai l u re t o rep o rto n t h e l at e-fi l edretu rn s h is i n t eres t an dSo ci al Secu ri ty i nco m e. Th e IRS, t hro u g h i t s rev en u e ag en t , requ es t ed d o cu m en t s fro m Can at el l a reg ard i n g h i s b u s i n es s i n co m e, i n teres ti nco m e, an dSo ci al Secu ri ty i n co m e. In res p o n s e, Can at el l a p ro v i d ed(1 ) a Qu i ck Bo ok s l ed g er an d(2 ) can cel edch eck s th ath adb een d ep os i t edi n t o h is m ai n b us i n es s ch eck i n g acco u nt , No . 9 6 6 7 . Th e d o cu m en t s
n ei th er referen cedth e o th er b an kacco u n t s recei v i n g i n t eres t i n co m e n o r
acco u n t edfo r d i s crep an ci es i n i n t eres tan dSo ci al Secu ri ty i n co m e. Th e IRS i s s u eds u m

m o n s es t o al l th e b an k s wh ere Can at el la h adacco u n ts
o p en du ri n g th e t h ree-y ear p eri o d . Us i n g t h e s u m m o n ed acco u n t i n fo rm at i o n , a b an k-d ep o s i t s an al y s is reco n s tru ct edCan at el l a’ s i n co m e. Inco n du ct i n g the b an k
d ep os i t s an al y si s , th e IRS: (1 ) t o t al edal l d ep o s i t s i n t o al l Can at el l a’ s b an k
acco u n t s, (2 ) s ub tract edo utal l d ep o s i t s (o r p o rt i o n s o f d ep o s i t s ) d et erm in edt o b e- 5
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[* 5 ] n o n t ax ab le, i ncl u d i ng i n t eracco u n ttran s fers an drefu n ds , an dd ep o s it s fro m
n o n t ax ab l e s o u rces , (3 ) s ub tract edth e am o u nt s o f i n co m e th atCan at el l a h ad rep o rt edo n h i s t ax return s, an d(4 ) d et erm i n edth atthe res ul t in g am o u n t fo r each y ear was Can at el l a’ s u n rep o rt edSch edu l e C g ro s s recei p ts . Ini t s b an k -d ep o s i t s
an al y s i s t h e IRS d i dn o td et erm i n e t hatan y d ep o si t s i n t o acco u ntNo . 9 1 9 3 were t ax ab l e b ecau s e i td et erm in edth atacco u n t No . 9 1 93 was an IOLTA acco u n t . An IOLTA acco u nt i s an acco u n tfo r cl ien tfu n ds th at are i n s m al l am o u n t s o r h el dfo r
s h o rtp eri o d s . Th e IRS p ro v i dedCan at el l a wi th a co p y o f t he b an k-d ep o s i t s an al y si s an d g av e h i m an o p p o rtu n it y

t o co n t es ti t . Can at el l a d i dn otfu rn i s h an y ad d i t i o n al d o cu m en t s t o co n tes t th e b an k -d ep o s i t s an al y s is
. Th e IRS m ai leda n o t i ce o f d efi ci en cy t o Can at el l a fo r 2 00 8 , 2 0 0 9 , an d2 0 1 0
o n M ay 3 1 , 2 0 13 . Refl ect i n g the b an k -d ep o s i t s an al y s i s , th e n o t i ce d et erm i n ed Can at el l a u n d er-rep o rt edh i s Sch edul e C i n co m e b y $ 2 8 5,7 25 fo r 2 0 0 8 , ($ 3 6 ,3 9 1 ) fo r 2 0 0 9 , 3 an d$ 23 2 ,8 2 7 fo r 2 01 0 . Th e n o t i ce d i s al lo wed cert ai n b u s i n es s -ex p en s e d educt i o n s Can at el l a cl ai m edo n h is Sch edul es C. Th es e d i s al l o wedd edu ct i o n s t o t al ed$ 3 3 6 ,4 7 8 fo r 2 00 8 , $ 2 5 0 ,3 2 0 fo r 2 0 0 9 , an d$ 1 4 4 ,2 2 7 fo r 2 0 10 . Th e n o t ice

3 Fo r 2 0 0 9 th e IRS d et erm i n edCan at el l a o v er-rep ort edh i s Sch edu l e C i n co m e b y

$ 36 ,3 9 1
.- 6
-

[* 6 ] d et erm i n edthatCan at el la h adfai l edt o rep o rti n t eres tan dSo ci al Secu ri ty i n co m e. Th e n o t i ce d et erm in edt ax d efi ci en ci es o f $ 2 4 8 ,2 62 fo r 2 0 0 8 , $ 9 2,7 5 8 fo r 2 0 0 9 , an d$ 1 2 8 ,1 6 7 fo r 2 01 0 an ds ect i o n 6 6 6 2 (a) p en al t i es o f $ 4 9 , 6 5 2 fo r 2 0 0 8 , $ 1 8 ,5 5 2 fo r 2 0 0 9 , an d $ 2 5,6 3 3 fo r 2 0 1 0
. III. St i p ul at i o n o f Set t l edIs s u es ; Co n ces s i on s Aft er t h e i s su an ce o f t h e n o t i ce o f d efi ci en cy , th e p art i es ex ecu t eda
s t ip u l at i o n o f s et t ledi s s u es . Th ey ag reed th atCan at el l a was en t it l edt o b u s i n es s ex p en s e d educt i o ns o f $ 1 0 5,3 8 4 fo r 2 0 08 , $ 7 6 ,0 1 6 fo r 2 0 09 , an d$ 8 0 , 7 5 3 fo r 2 0 1 0 fo r cat eg ori es i n wh i ch h e h ad cl ai m edd educt i o n s o n h is Sch edul es C. Th e p art i es al s o ag reedth atCan at el la was en t i t l ed t o b u s i n es s -ex pen s e d edu ct i o n s o f $ 1 0 8 ,4 6 2 fo r 2 0 0 8, $ 68 ,3 60 fo r 2 00 9 , an d $ 2 4 ,9 3 6 fo r 2 0 1 0 fo r cat eg o ri es i n wh i ch h e h adn o tcl ai m edd edu ct i o n s o n h is Sch edu l es C. 4 Th e p art i es ag reedo n th e am o un t s o f u n rep o rt edi n t eres ti n co m e an dSo ci al Secu ri ty i nco m e fo r each

4 In th e cat eg o ri es o f b us i n es s -ex p en s es fo r wh i ch Can at el la h adn o t cl ai m ed an y d educt i o ns o n h i s Sch edu l es C, th e s t i p u l at io n o f s et t l edi s s u es s t at es that Can at el l a i s en t i tl edt o d edu ct i o n s o f “ atl eas t ” $ 9 0,4 1 7 fo r 2 0 0 8 an d$ 5 4 ,1 1 2 fo r 2 0 0 9 fo r “ cas e co s t s an dp aym en t s t o cl i en t s ”. Th u s , th e s t i p u l at i on o f s et t l ed i s su es p res erv edCan at el l a’ s ri gh tt o p ro v e h i s en t i tl em en tt o d educt i o n s fo r “ cas e co s t s an dp aym en t s t o cl i en ts ” ab o v e thes e d o l l ar t hres h o l d s fo r b o th y ears . Bu ti n h i s b ri ef, Can at el l a d i s pu t es o n l y wh et h er d ep o s it s are p ro p erl y i n cl u dab l e i n h i s i n co m e, n o twh et h er h e i s en t i tl edt o d edu ct io n s fo r t he p aym en t o f t h e d ep o s i t ed fu n d s t o h i s cl ien t s . He h as therefo re wai v edan y arg u m en treg ard in g th es e d educt i o n s . See Ru l e 1 5 1; Ni ck l au s v . Co m m i s s i o n er, 1 1 7 T.C. 1 17 , 1 2 0 n .4 (2 0 0 1).- 7
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[* 7 ] y ear. (Th es e am o u nt s t o t al ed$ 7 0,9 7 5 o f i n t eres ti n co m e an d$ 3 9,1 5 4 i n So ci al Secu ri ty

i n co m e fo r al l th ree y ears . ). Th ey ag reedth at Can at el la i s l i ab l e fo r t h e n eg li g en ce p en al ty u n d er s ect i o n 6 6 62 (a) fo r 2 0 0 8 , 2 0 0 9 , an d 2 0 1 0
. 5 Th e p art i es d i dn o tag ree o n th e am o u n t s o f Can at el la’ s Sch edu l e C g ro s s recei pt s . In i t s b ri ef t h e IRS co n ced edth at acco u n tNo . 3 4 2 7 i s an IOLTA acco u n t
an d th atn o n e o f t h e d ep os i ts i n t o th e acco un tth ati td et erm i ned t o b e t ax ab l e as p arto f i ts b an k -d ep o s i t s an al y s i s are i n cl u dab l e i n Can at el la’ s i n co m e. Rem ai n i n g ati ss u e i s th e v al i d it y

o f the b an k -d ep o s it s an al y s is as a wh o l e an d , al t ern at i v el y , th e t ax ab i l i ty

o f fo u r d ep o s i t s t h atCan at el la s peci fi cal l y ch al l en g es . OPINION 1
. Des i g n at edRep res en t at i v e Atth e b eg i n n in g o f t ri al , Can at el l a req u es t edthatal l wi tn es s es b e ex cl u d ed fro m th e co u rt ro o m

u n d er Ru l e 1 4 5 . Th e Co urto rd eredal l wi tn es s es ex cl u d ed fro m th e co u rt ro o m , b u tm ad e an ex cep t i o n fo r t h e rev en u e ag en t . Th e rev en u e ag en t was d es ig nat edth e IRS’ s rep res en t at i v e b y th e t ri al at t o rn ey s fro m

th e IRS Offi ce o f Ch i ef Co un s el . Th erefo re t he rev en ue ag en t was p ro p erl y p erm i t t edt o
rem ai n i n th e co urt ro o m

u n d er t h e ex cep t i o n i n Ru l e 1 45 (a) fo r “ an o ffi cer o r

5 Onb ri ef Can at el l a d is p ut es h i s l i ab i l i ty fo r t h e s ec. 6 6 6 2 (a) p en al t i es , b u t h e i s b o un d b y

th e s t ip u l at i on o f s et t l ed i s s u es . See Ru l e 9 1 (e).- 8
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[* 8 ] em pl o y ee o f a p art y

wh ich i s n ota n atural p ers o n d es i g n at edas i t s rep res en t at i v e b y

i t s at t o rn ey .” Can at el l a co n t en d s i n h i s b ri ef th atth e d es i g n at ed rep res en t at i v e o f t h e IRS was th e t ri al at t o rn ey ’ s s uperv i s i n g at t o rn ey (wh o al s o
was i n th e co u rt ro o m ) an dth atth erefo re t he rev enu e ag en tco u l d n o tal s o b e t h e d es i g n at edrep res en t at i v e. Ho wev er, th e s up erv i s i n g at t orn ey was n o t th e IRS’ s d es i g n at edrep res en t at i v e u n d er Ru l e 1 45 (a). 2
. Al l eg edM i s co n du ct b y IRS Tri al At t o rn ey Onb ri ef, Can at el l a cl ai m s the IRS’ s t ri al at to rn ey v i o l at ed Ru l es 1
- 1 0 2 (a)(4 ) an d 1 -1 0 2 (a)(5 ) o f t h e 1 9 6 9 Am eri can Bar As s o ci at i o n M o d el Co d e o f Pro fes s i on al Res p o n si b il i ty (“ M o d el Co d e”) b y

frau du l en t l y

s t at i n g th atCan at el l a h ad b een g iv enth e l at es tv ers i on o f t h e s ti pu l at ed ex hi b i t s b efo re tri al
. Pract i t i o n ers b efo re th i s Co urt are n otreq ui redt o co m p ly wi th th e M o d el Co d e. Ho wev er, th ey

are req ui redt o co m

p l y wi th th e Am eri can Bar As s o ci at i o n M o d el Ru l es o f Pro fes s i o n al Co n duct(“ M o d el Ru l es ”). Ru l e 2 0 1 (a). Sect i o n s 1
- 1 0 2 (a)(4 ) an d 1 -1 0 2 (a)(5 ) o f t h e M o d el Co d e co rres po n dt o Ru l e 8 .4 o f t h e M o d el Ru l es . W e are u n co n v i n cedth atth e IRS’ s tri al at t o rn ey en g ag edi n an y

ty p e o f
m i s co n du ct . Duri n g tri al , the t ri al at t o rn ey rep res en t edo n l y

th at : (1 ) m i s l ab el ed
v ers i on s o f t h e d o cu m en t s were ex ch an g edb efo re tri al an d (2 ) Can at el l a was n o t
wo rk i n g fro m

th e co rrect v ers i on attri al . Aft er s he d i s co v eredthe d i s crep an cy th e- 9
-

[* 9 ] tri al at t o rn ey t o o kth e i n i t i at i v e t o co rrect th e p ro b l em s o th atCan at el l a co u l d p ro p erl y cro s s -ex am in e the wi tn es s . Acco rd i n g l y , we fi n dn o b as is fo r Can at el l a’ s al l eg at i o n o f m i s co n du ct . 3
. Ban k -Dep o s i t s An al y s i s Th e n o t i ce o f d efi ci en cy

d et erm i ned , o n t h e b as i s o f t h e IRS b an k -d ep o s i t s
an al y s i s, th e am o un t s o f Can at el l a’ s t o t al g ro s s recei p t s an dh is u n rep o rt edg ro s s recei p t s. Onb ri ef t h e IRS co n ced es th atth e d ep o s i t s i n t o acco u ntNo . 3 4 27 are
n o tg ro s s i n co m e t o Can at el l a. Th e rel ev an tam o u n t s are s u m m ari zedb el o w: It em 2 00 8 2 0 0 9 2 01 0 To tal g ro ss recei p t s acco rd i n g t o n o ti ce o f d efi ci en cy $ 7 9 5,2 1 1 $ 3 4 5,4 8 1 $ 4 0 3,4 8 1 Un rep o rt edg ro s s recei p t s acco rd in g t o n o ti ce o f d efi ci en cy 2 8 5,7 2 5 -3 6 ,3 9 1 2 3 2,8 2 7 Un rep o rt edg ro s s recei p t s aft er co n ces si o n b y IRS i n b ri ef reg ard i n g acco un tNo . 3 4 2 7 2 6 0,7 2 5 -3 6 ,3 9 1 1 4 1,4 4 8 Gro s s i n co m e g en eral l y

i n cl ud es “ i n co m e fro m

wh at ev er s o urce d eri v ed ”
u n l es s s p eci fi cal l y ex cl ud edb y s t atu t e. Sec. 6 1 (a). Tax p ay ers are req ui redt o
m ai n t ai n reco rd s s u ffi ci en t t o es t ab l i s h th e am o u n t s o f i n co m e, d edu ct i o n s , an d
o th er i tem s wh i ch u n d erl i e th ei r fed eral i n co m e t ax l iab i l i ti es . Sec. 6 0 01 ; s ec. 1 .6 00 1 -1 (a), (e), In co m e Tax Reg s . If a t ax p ay er fai l s t o k eep ad equat e b o o k s an d- 1 0 -

[* 1 0 ] reco rd s, th e IRS m ay reco n s tru ctth e t ax p ay er’ s i n co m e b y an y m et h o dth at i s reas on ab l e u n der t h e ci rcu m s t an ces . Pet zo l d t v . Co m m i s s i on er, 9 2 T.C. 6 6 1 , 6 8 7 (1 98 9 ). Th e reco n s tru ct i o n n eedn o tb e ex act , s o l o n g as i t i s reas o n ab l e an d
s ub s t an t i al l y

co rrect . Id . at 6 9 3 ; M en eg u zzo v . Co m m is s i o n er, 4 3 T.C. 8 2 4 (1 9 6 5). Th e u se o f b an kd ep os i t s i s reco g n izedas a reas o n ab l e m etho d o f
reco n s tru ct i n g i n co m e. Park s v . Co m m i s s i o n er, 9 4 T.C. 6 5 4 , 6 5 8 (1 99 0 ); To k ars k i
v . Co m m i s s i o n er, 8 7 T.C. 7 4 , 7 7 (1 9 8 6 ); Ni ch ol as v . Co m m is s i o n er, 7 0 T.C. 1 05 7 , 1 0 6 5 (1 9 7 8 ). “ Th e b an kd ep o si t s m et h o d as s u m es th atal l m on ey d ep os i t edi n a t ax p ay er’ s b an kacco u n t du ri n g a g i ven p eri o dco n st i tu t es t ax ab l e i n co m e, b u tth e Go v ern m en tm

u s tt ak e i nt o acco u n tan y n o n t ax ab l e s o u rce o r d edu ct i b l e ex p en s e
o f wh ich i t h as kn o w l ed g e.” Cl ayt o n v . Co m m i s s i o n er, 1 0 2 T.C. 6 3 2 , 6 4 5 -6 4 6 (1 9 9 4) (ci t i n g Di Leo v . Co m m is s i o n er, 9 6 T.C. 8 5 8 , 8 67 (1 9 9 1 )), aff’ d, 9 5 9 F.2 d 1 6 (2 d Ci r. 1 9 92 ). Th e n o t i ce o f d efi ci en cy i s s u edt o Can at el la refl ect ed the
co n cl u s i o n s o f t he IRS b an k -d ep o s i t s an al y s i s i n i t s g ro s s -recei p t s d et erm i n at i o n s . As a g en eral ru l e, a t ax p ay er b ears the b u rd en o f p ro v in g th e IRS’ s d et erm i n at i o n s i n a n o ti ce o f d efi ci en cy

t o b e i n erro r. Ru l e 1 4 2 (a). Sect io n 7 4 9 1 (a), wh i ch s h i ft s th e b u rd en o f p ro o f t o th e IRS u n d er cert ai n ci rcu m s t an ces , d o es n o tap p l y wi th res p ectt o an y fact u al d i s p u t e i n thi s cas e b ecau s e Can at el l a d i dn o tk eep ad equ at e b o o k s an d reco rd s . See s ec.- 1 1 -

[* 1 1 ] 7 4 9 1 (a)(2 )(A) an d(B). He cl ai m s thath e k ep th is l aw-p ract i ce b o ok s o n a
co m p u t er p ro g ram

cal l ed Qu i ck Bo o k s . He g av e t he p ri n t o u t s fro m Qu i ck Bo o k s t o th e IRS d u ri n g th e ex am i n at i o n . Ho wev er, t h e rev en u e ag en tcred i b l y t es t i fi ed th atth e Qu i ck Bo o k s p ri n t o ut s co v eredo nl y o n e o f Can at el l a’ s b u s i n es s acco u n t s (Can at el l a d idn oti n tro du ce t h e Qu i ck Bo o k s p ri n t o u ts attri al ). Th e U.S. Co urt of Ap p eal s fo r t h e Ni nt h Ci rcu i treco g ni zes an o th er
ex cep t i o n t o th e g en eral ru l e wh ere t h e n o t i ce o f d efi ci en cy d et erm i n es th atth e t ax p ay er fai l edt o rep o rti n co m e. Ll o ren te v . Co m m i s s i o n er, 6 4 9 F.2 d1 52 , 1 5 6 (2 dCi r. 1 9 8 1), aff’ g i n p artan drev ’ g i n p art7 4 T.C. 2 60 (1 9 8 0 ); W ei m ers k i rch v . Co m m i s s i o n er, 5 9 6 F.2 d3 5 8 (9 th Ci r. 1 9 79 ), rev ’ g 6 7 T.C. 6 7 2 (1 9 7 7 ). In s u ch ci rcu m s t an ces , th e IRS m u s tco m e fo rwardwi th ev id en ce es t ab l i s h i n g a m i n i m al fo u n dat i o n , wh i ch m ay

co n s i s t o f ev i d en ce l i n k i n g th e t ax p ay er wi th an i n co m ep ro duci n g act i v i ty . Pet zo l dt v . Co m m is s io n er, 9 2 T.C. at6 8 9 . Can at el l a d o es n o t d i s p u t e t h ath e recei v ed i n co m e fro m h is l aw p ract i ce. Ho wev er, h e co n t en d s th at th e IRS’ s d et erm i n at io n s o f u n rep o rt edg ro s s recei p t s s ho u l dn o t b e s u s t ai n ed b ecau s e th e b an k reco rd s u s edb y th e IRS “ di dn o ts p eci fy the t ax ab l e o r
n o n t ax ab l e n ature o f t h e d ep os i t s ”. Iti s a fu n d am en tal p ri n ci p l e u n derl y i n g th e b an k-d ep o s i t s m et h o d t h atal l d ep o s i t s are p res u m p t i v el y t ax ab l e. Un i t edSt at es v . St o n e, 7 7 0 F.2 d 8 4 0 , 8 4 4 (1 9 8 5 ). If Can at el l a i s co rrect th atth e b an k -d ep o s i t s- 1 2 -

[* 1 2 ] m eth o dcan b e u s edo n l y wh en th e b an k reco rd s s ho w wh et h er t h e d ep o s i t s are t ax ab l e (i .e. i n cl u d ab l e i n g ro s s i n co m e fo r t ax p u rp o s es ), th en th e b an k
d ep os i t s m et h o dco u l d n ev er b e u s ed . Th e b an kreco rd s rel i edo n b y th e IRS n eed
n o ts p eci fy

th e t ax ab l e o r n o nt ax ab l e n atu re o f t h e d ep os i t s . Nex t , Can at el l a co n t en d s th atth e IRS h as i n co rrect l y co ncl u d edth ats o m e b an k d ep o s i t s were i n co m e an d t h at th erefo re al l o f t h e res u lt s o f i ts b an k -d ep o s i t s
an al y s i s s h o ul db e reject ed . It i s tru e t h atth e IRS h as i nco rrect ly co n cl u d edth at
s o m e b an kd ep o s i t s were i n co m e. Th i s i s i l l u s trat edb y i t s co nces s i o n o n b ri ef t h at i t in co rrect l y d et erm i n edth at d ep o s i t s i nt o acco un tNo . 3 42 7 were i n co m e. An d , as we ex p l ai n l at er i n th is o p i n i o n , we h o l dth ato n e d ep o s it(an dp o rt i o n s o f t wo
o th er d ep o s i t s ) were i nco rrect l y d et erm in edb y th e IRS t o b e i n co m e. Ho wev er,
co u rt s reco g ni ze t h ats o m e erro rs are u n av o i d ab l e wh en an i n di rect m et h o di s u s ed t o reco n s tru cti n co m e, es p eci al l y wh ere t h e t ax pay er h as fai l edt o m ai n tai n ad equat e reco rd s . Un i t edSt at es v . St on eh i l l , 7 0 2 F.2 d1 2 88 , 1 2 9 6 (9 th Ci r. 1 9 8 3 ). In th i s cas e, t h e IRS m ad e an effo rtt o d et erm i n e wh ich d ep o s i t s were at tri b u t ab l e t o n o n tax ab l e s o u rces (an di n d eed , i td et erm in edth ats o m e d ep o s i t s were at tri b u t ab l e t o n on t ax ab le s o u rces ). Cf. W es tb y v . Co m m i s s i o n er, T.C. M em o . 2 0 0 4 -1 7 9 (b an k-d ep o s i t s an al y s i s i n v al i d wh ere IRS d i dn o tm ak e ad ju s t m en t s fo r- 1 3 -

[* 1 3 ] n o n t ax ab l e i t em s ). W e wi l l n o trejectth e IRS’ s b an k -d ep o s it s an al y s i s i n i t s
en t i ret y m erel y b ecau s e o f t h es e few i n co rrect d et erm i n at i o ns . Nex t , Can at el l a co n t en d s th atth e b an k -d ep o s it s m et h o di s u n n eces s ary b ecau s e h e k ep t reco rd s o f h is i n co m e t h ro u gh Qu ick Bo o k s. Bu tas al read y
ex p lai n ed , h e ap p aren t l y

u s edQu ick Bo o k s t o tracko n l y o n e o f h i s b u s i n es s
acco u n t s. Fu rt h er, h e d id n o tp ro du ce t h e Qu i ck Bo o ks reco rd s attri al . Th erefo re
we are u n ab l e t o co n cl u d e t h atth e IRS was u n reas o n ab l e i n en g ag i n g i n i ts o wn
m et h o d o f d et erm i n i n g Can at el l a’ s i nco m e. W e t h erefo re reject Can at el l a’ s arg u m en tth atth e res u lt s o f t h e b an k -d ep o s it s an al y s i s s h o u l d b e cat eg o ri cal l y d i s m i s s ed
. Can at el la i s s t i l l en t i t l edt o p ro v e t h ata p art i cu l ar d ep o s iti s n ott ax ab l e. See Cl ayt o n v . Co m

m i s si o n er, 1 0 2 T.C. at6 4 5-6 4 6 . Can at el l a t ak es up th i s ch al l en g e wi th res p ect t o fo u r s p eci fi c d ep o s i ts m ad e i n 2 0 0 8
. Th e fi rs td ep o si twas a $ 6 1 ,4 8 7 d ep o s i ti n to acco u n t No . 2 2 9 3 o n Feb ru ary 1 2 , 2 0 0 8 . Th i s d ep o s i twas a t ran s fer fro m th e acco un tth atth e p art i es ag ree was
an IOLTA acco u n t , IOLTA No . 9 19 3 . Th ree d ay s b efo re t h i s i n t eracco u n t tran s fer, Can at el l a h add ep os i t edi n t o IOLTA No . 9 1 93 a ch ecki n th e ex act
am ou n to f t h e t ran s fer. Th e ch eckwas fro m Res i d en t ial M o rt g ag e Cap i t al an d
was wri tt en t o Deb orah Do l ch as co ns erv at o r fo r El i zab et h Zu t. On th e s am e d ay- 1 4 -

[* 1 4 ] as th e $ 6 1 ,4 8 7 i n t eracco u n ttran s fer fro m IOLTA No . 9 1 9 3 t o acco u ntNo
. 2 2 9 3 , Can at el l a wro t e a $ 20 ,0 00 ch eck t o El i zab eth Zu tdrawi n g o n acco u ntNo
. 2 2 9 3 . Can at el l a as sert s th e $ 6 1 ,4 8 7 d ep o s i ti s n o tt ax ab l e t o h im b ecau s e acco u n t No . 2 2 9 3 i s a cl i en t-t ru s t acco u n t . He refers t o acco u ntNo . 2 2 9 3 i n h i s b ri ef as th e “ Z u tco n s erv at o rs h i p d i s tri bu t i o n acco un t ”. As a g en eral ru l e, fu n d s th ata t ax p ay er recei v es i n t ru s tfo r an ot h er p ers o n
are n o ti n cl u d ab le i n th e t ax p ay er’ s g ro ss i nco m e. Fo rd Deal ers Adv ert . Fu n d , In c.
v . Co m m i s s i o n er, 5 5 T.C. 7 6 1, 7 7 1 (1 9 7 1 ), aff’ d , 4 5 6 F.2 d2 5 5 (5 th Ci r. 1 9 7 2 ). Un d er t h is g en eral ru l e, i f a l awy er recei v es fu n d s th atp ro fes s io n al reg u lat i o n s req u i re t o b e s eg reg at ed fro m o th er fu n d s an dacco u n tedfo r s ep arat el y , th e fu n d s
are n o ti n cl u d ab le i n th e i n co m e o f t h e l awy er. M i el e v . Co m m is s i o n er, 7 2 T.C. 2 8 4 , 2 9 0 (1 9 7 9). Un d er th e Cal i fo rn i a Ru les o f Pro fes s io nal Co n du ct , Can at el l a
was req u ired t o h o l dal l cl i en tfu n d s i n b an kacco u n t s th atwere l ab el ed “ Tru s t Acco u n t ”, “ Cl ien t ’ s Fu n d Acco u n t ”, o r s o m et h i n g s im i l ar. Cal . R. Pro f. Co n du ct 4 -1 0 0(A). He was p ro h i b it edfro m co m m i n g l i n g cl i en tfu n d s wi th h i s o wnfu n d s . Id . at4 -1 0 0 (A)(2 ). Can at el la was al s o req u i redt o k eep d et ai ledreco rd s o f cl i en t fu n d s, i n cl u d in g a l ed g er fo r each cl i en ts h o w i ng al l fu n d s h e recei v edo n b eh al f
o f t h e cl i en tan dal l d i s b u rs em en t s h e m ad e o n b eh al f o f t h e cl i en t . Id . at 4 -1 0 0(B)(3 ); Bo ardo f Go v ern o rs o f t h e St at e Bar o f Cal i fo rn ia, Tru s tAcco u n t- 1 5 -

[* 1 5 ] Reco rdKeep i n g St an d ard s (1 9 9 2 ), h ttp : //www.cal b ar.ca.g ov / At t o rn ey s / Co n du ct -Di s ci p l i n e/ Ru l es / Ru l es -o f-Pro fes s i o n al -Co n du ct/ Cu rren t -Ru les / Ru l e-4 -1 0 0 . Acco u n t No . 2 2 9 3 was n o tl ab el ed a cl i en ttru s tacco u nt . Can at el l a ro ut i n el y
u s ed th e acco u n t t o d ep o s i th i s l eg al fees , t o p ay h i s b u si n es s ex p en s es , an dt o p ay h i s p ers o n al ex p en s es . He d i dn o ti n tro duce as ev i d en ce an y o f t h e l ed g ers req u i redfo r cl i en ttru s tacco un t s . No r d i dh e s h ow t h ath e h ads u ch l ed g ers fo r
acco u n t N o . 2 2 9 3 . Thu s , Can at el l a d i dn o tfo ll o w th e l ab el i n g , an t i co m m i n g l i n g , an d reco rd -k eep i n g req ui rem en t s fo r m ai n tai n i n g acco un tNo . 2 29 3 as a cl i en t tru s tacco u n t . No n eth el es s , we co n cl u d e th atCan at el l a treat ed$ 2 0 ,0 0 0 o f t h e $ 6 1 ,4 6 7 d ep o s i t as th e fu n d s o f h i s cl i en tEl i zab et h Zu t . Can at el l a p ai d$ 2 0 ,0 0 0 t o Zu ti m m ed i at el y aft er t h e t ran s fer o f the $ 6 1 ,4 6 7 d ep o s i t . Un d er t h e ci rcu m s t an ces , $ 2 0,0 0 0 o f t h e $ 6 1 ,4 6 7 was n ot“ treat ed ” b y Can at el l a as

“ b el o n g i n g t o h i m .” See Heal y v . Co m m i s s io n er, 3 4 5 U.S. 2 78 , 2 8 2 (1 9 5 3 ). Iti s
n o ti n cl u d ab l e i n h i s i n co m e. Th e s eco n dd ep o s i t i s a $ 4 0 ,9 6 0 i n t eracco u n ttran s fer o n Ap ri l 4 , 2 0 0 8 . Th e tran s fer m o v edm o n ey fro m IOLTA No . 9 1 9 3 t o acco u n tNo
. 2 29 3 , th e acco u n t th atal leg ed l y

was th e Zu tco n s erv at o rs h i p d i s tri b u t i on acco un t . Th e d ay b efo re th i s tran s fer, Can at el la d ep o s it eda $ 1 5 0,0 0 0 ch ecki n to IOLTA No . 9 1 9 3 . Th e $ 1 5 0 ,0 0 0 ch eckwas wri t t en b y th e Al l s t at e In s uran ce Co . t o “ Co t t er & Del Carl o- 1 6 -

[* 1 6 ] Tru s tAcco u n t ”. Can at el l a cl ai m s t hath e t ran s ferred$ 4 0 ,9 6 0 fro m IOLTA No . 9 1 9 3 t o acco un tNo . 2 2 9 3 i n o rd er t o k eep th e $ 4 0 ,9 6 0 i n tru s tfo r LaRel l Fran k l i n , o n e o f s ev eral h ei rs en t i tl edt o th e p ro ceed s o f t h e $ 1 5 0 , 0 0 0 ch eck
. Ho wev er, atth e s am e t i m e h e t ran s ferred $ 4 0 ,9 6 0 t o acco u nt No . 2 2 93 , Can at el l a
m ad e a $ 2 8 ,9 7 0 d is tri b u t i on d irect l y t o Fran k li n (as wel l as d i s tri b u t i o n s t o fo u r
o th er h ei rs ). Can at el l a arg u es o n b ri ef t h ath e h adth e au th o ri ty t o h o l dth e $ 4 0 ,9 6 0 i n tru stwh il e Fran k l i n was i n carcerat ed . Bu tth ere i s n o ev i d en ce t h at Fran k l i n g av e t h i s au th o ri ty t o Can at el l a, t h atFran k l i n was i n carcerat ed , o r t h at Can at el l a d i st ri b u t ed th e $ 4 0 ,9 6 0 t o Fran kl i n aft er h i s rel eas e. Fu rt h erm o re, Fran k l i n recei v ed $ 2 8 , 9 7 0 i m m ed i at el y aft er Al l s t at e p ai dth e $ 1 5 0 ,0 0 0
s et t l em en t . As a res u l t , we are n o tco n vi n ced th atth e $ 4 0 ,9 6 0 tran s fer fro m IOLTA No . 9 1 9 3 t o acco u n tNo . 2 2 93 was o f fu n d s h el di n tru s tfo r Fran kl i n . Th e t h ird d ep o s i ti s a $ 1 50 ,0 0 0 ch eckfro m Fi d el it y Nat i o nal Ti t le In s u ran ce Co . t o “ Jo an Ro b ackan dCo t t er & Del Carl o, h er at t o rn ey s ”. Th e ch eck was d ep os i t edi n t o acco u n t No . 1 6 2 9 o n M ay 2 9, 2 0 08 . Can at el l a arg u es th atth i s
acco u n t is a n o n -IOLTA cl i en t tru s t acco u n t. Bu t th e acco u n t was n o tl ab el eda cl i en t tru s tacco u n t . Th e acco un tco n t ai nedco m m i n g l edfu n d s . Th ere i s n o
ev i d en ce a cl i en t led g er was k ep t . Thu s , Can at el l a d i dn o tfo l l o wthe Cal i fo rn i a Ru l es o f Pro fes s i o n al Co n ductfo r cl i en t tru s t acco u n t s as t o acco un tNo . 1 6 2 9
.- 1 7 -

[* 1 7 ] Bu ti ti s al s o s i g n ifi can tth atth ree d ay s aft er h e d ep o s it edthe $ 1 5 0 ,0 0 0 ch ecki n to acco u nt No . 1 6 2 9 , Can at el l a wro t e an $ 8 0 ,0 00 ch eckdrawi n g o n
acco u n t N o . 1 6 2 9 t o J o an Ro b ackwi th th e wo rd“ Set t l em en t” o n th e m em o ran du m l i ne. Si m u l t an eo u s ly

wi th th at$ 8 0 , 0 0 0 d ep o s ith e t ran s ferred$ 3 2 ,0 0 0 fro m
acco u n t N o . 1 6 2 9 t o h i s m ai n o p erat i n g acco u n t, No . 9 6 6 7 . Can at el l a arg ues th at h e l eft $3 8 , 0 0 0 o f t h e $ 1 5 0,0 0 0 i n acco u ntNo . 1 6 2 9 t o p ay “ fu tu re l i t ig at i o n
co s t s ”. He cl ai m s h e i s n o t t ax ab l e o n t h e $ 1 5 0 ,0 0 0 t o th e ex t en to f (1 ) t h e $ 8 0 ,0 0 0 tran s ferred t o Ro backan d(2 ) th e $ 3 8 ,0 0 0 rem ai n i n g i n acco u n t No . 1 6 2 9
. Hi s cl ai m th at $ 3 8 ,0 0 0 was u s edt o p ay “ fu tu re l i t ig at i o n co s t s ” i s n o t s up p o rt ed b y th e reco rd . Of th e $ 1 5 0 ,0 0 0 d ep o si t , o n l y $ 8 0,0 00 was cl i en tfu n d s o f Ro b ack
an d was n o ti n cl u dab l e i n Can at el l a’ s i n co m e. Th e fo u rt h d i s p u t edd ep o s i ti s a $ 2 4 , 0 0 0 d ep o s i to f a ch eck fro m Can at el l a’ s
s o n . Th e d ep o s i twas m ad e i n t o acco u n tNo . 2 2 9 3 , th e acco u n tth atCan at el l a cl ai m s i s t h e Zu tco n s erv at o rs hi p d i s tri b u t i o n acco u nt , o n Ap ri l 2 3, 2 0 0 8
. Can at el l a t es t i fi edthatthi s $ 2 4 ,0 0 0 ch eckwas a rep aym en to f m o ney h e h adl en t h i s s o n . See, e.g ., Co m

m i s s i o n er v . Tu ft s , 4 6 1 U.S. 3 0 0, 3 0 7 (1 9 8 3). Bu tth ere i s
n o l o an d o cu m en ti n t h e reco rd . No r d i dCan at el l a rep o rtth ath e earn edan y i n t eres to n th e l o an fo r t h e l as tth ree y ears . Thu s , we are rel u ct an tt o co n cl u d e t hat th e $ 2 4,0 0 0 d ep o si twas a l o anrep aym en t. Ho wev er, we o b serv e t hatth e $ 2 4 ,0 0 0- 1 8 -

[* 1 8 ] d ep o s iti s al s o n o n t ax ab l e i f i ti s a g i ft . Sec. 1 0 2 (a). Th ere i s n o ev id en ce th atCan at el la was p erfo rm i n g l eg al s erv i ces fo r h i s s on . W e b el iev e i t i s m o re l i kel y th an n o tth atth e $ 2 4 , 0 0 0 d ep o s i twas ei th er a g i fto r a rep aym en to f a l o an . Th erefo re we h ol d t h ati ti s n o n t ax ab l e. In co n cl u s i o n , we h o l dthatth e am o un t o f d ep o s i t s d et erm i n edb y th e IRS t o b e i n cl u d ab l e i n Can at el la’ s i n co m e fo r t h e t ax y ear 2 0 0 8 s ho u l db e redu cedb y $ 8 0 ,0 0 0 + $ 2 0 ,0 0 0 + $ 2 4 ,0 0 0 = $ 12 4 ,0 0 0. W e h av e co n s id eredal l o f t h e arg um en t s th e p art i es h av e m ad e, an dt o th e
ex t en tth atwe h av e n o t di s cu s sedth em , we fi n dth em t o b e i rrel ev an t , m o ot , o r wi th o u tm eri t . To refl ectthe fo reg o i n g , Deci s i o n wi ll b e en t eredu n d er Ru l e 1 5 5
.