A recent United States Tax Court decision, issued on December 12, 2019, demonstrates the potential consequences and penalties that can arise from failing to maintain adequate business records to substantiate claimed income and deductions.

The case of McRae v. Commissioner, T.C. Memo 2019-163, was decided against the taxpayers, Randy and Shelby McRae, leaving them with a tax bill of $84,544 for unreported income and additional accuracy-related penalties for the tax years of 2013–2015.

The McRaes’ tax returns for 2013–2015 were selected by the IRS for audit. Because of inadequate records for their Schedule C (sole proprietorship) business activities, the IRS performed a bank deposit analysis, and determined that income was substantially underreported.

The IRS issued a Notice of Deficiency to the taxpayers and disallowed various deductions claimed on the McRae’s Schedule C’s, as well as itemized deductions for mortgage interest expenses and all NOL deductions. Accuracy-related penalties were also proposed for the tax years of 2013–2015. The McRaes filed a Tax Court Petition against the IRS, challenging its decision.
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