Glen and Diane Flood owned and operated Flood’s Auto Parts andGlenwood Wrecker Service in Chatsworth, Georgia. The companies’offerings to the local market included the sale of wholesale andretail auto parts, a wrecker service, and the sale of wreckedautos. Mr. Flood did not consistently prepare invoices forcustomers and had no other way to determine total sales for hisbusinesses. Although Mr. Flood deposited some of the cash revenueinto the company’s bank accounts, he stored some of it in a safe athis home.
Over several years, Mr. Flood purchased multiple businesses andsold all or parts of others. The terms of payment were not alwaysrecorded in written form, and not all of them were reported onSchedule C of Mr. Flood’s individual tax returns.
Through a routine examination of the company’s tax returns, anIRS examiner discovered that Mr. Flood had not reported all of thesales generated by his businesses. Specifically, the examinerdetermined that Mr. Flood had understated taxable income for 1991,1992, and 1993 by $28,195, $22,695, and $74,013, respectively.
The Floods challenged the IRS audit findings, specifically that:(1) Mr. Flood failed to maintain adequate books and records; (2)sales were routinely omitted from the recordkeeping process; (3)employees may have forgotten to record sales; (4) not all cashrevenue was deposited in the bank; and (5) Mr. Flood was aware ofthese failures and chose to withhold this information from the taxpreparer.
The tax court’s memorandum is available at www .ustaxcourt.gov.At the homepage of this site, select the “Opinions Search” tab.Then, use the case keywords feature and enter: “Flood.” A case withthe name Glenn H. and Diane J. Flood will be among the caseslisted. Select this case for further use.
After reading the case, respond to the following questions.
1. What method did the IRS examiner use to determine the amountof unreported income? Why did the IRS examiner select this as anappropriate method for this case?
2. Explain how the source and application of funds methodworks.
3. Using the data presented in the case, recreate in an Excelspreadsheet the source and application of funds worksheets for1991, 1992, and 1993. Then provide an explanation of how eachcomponent of the spreadsheet contributes to the reconstruction oftaxable income. In other words, explain the methodology employed bythe IRS examiner.
4. In what specific area did the Floods disagree with the IRSexaminer’s findings? If the Floods are correct, what impact wouldit have on the amounts calculated as unreported income? How did thetax court rule on this matter?
5. How did the tax court view the indirect methodology used bythe IRS examiner to develop unreported income?
6. How did the tax court determine whether a loan from Mr. Floodto his father was in fact a loan that became worthless in 1992? Howdid the tax court rule?
7. The IRS examiner determined that a 20% accuracy penalty onthe unreported amounts was appropriate. What was the basis for thisdetermination? How did the court rule, and why?
8. why was this case tried in the U.S Tax court rather than U.S.District court? What is the difference? Who decides?
This question is from Forensic Accoounting by RufusMiller and Hanh. It is in Chapter 12 Page 397 Problem12-85.
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