The case Armond Garibyan, et al. v. Commissioner of Internal Revenue, T.C. Memo. 2025-105, addresses significant disputes concerning reconstructed income, disallowed business deductions, and accuracy-related penalties for the 2015 and 2016 tax years.

Case Overview and Factual Background

The petitioners include Lakeview Hospice Care, Inc. (Lakeview), a California C corporation founded by brothers Armond and Arsen Garibyan, and Armond and his wife, Ani Garibyan. Lakeview’s business, focused on caring for terminally ill patients, depended almost entirely on reimbursements from third parties, primarily Medicare, Medi-Cal, and private insurers. The complex structure of Lakeview’s operations included "pass-through billing," requiring the hospice agency to reimburse nursing facilities for room and board expenses before billing the insurers.

Crucially, Lakeview adopted the accrual method of accounting. However, the Commissioner audited the corporate and individual returns after observing that Lakeview’s corporate ledger rarely showed income and expenses as they accrued during the year.

The court noted severe deficiencies in Lakeview’s internal recordkeeping that rendered the corporate books wholly inadequate against the requirements of the Code. Examples of these deficiencies included:

The general ledger rarely debited accounts receivable, despite regularly receiving payments from insurance companies.
An unusual reversal of accounts receivable from $110,975 to $0 at the beginning of the 2016 fiscal year without intervening entries.
An excessive number of adjusting journal entries, such as reversing $106,490 in accounts-payable balances in 2016 simply by writing “Journal Entry” and “Reverse of Year End Accruals”.

These substantial inconsistencies and the inability to reconcile profit-and-loss statements with the returns led the Commissioner to use a bank-deposits analysis to reconstruct the company’s income.

Taxpayers’ Request for Relief

Lakeview and the Garibyans contested the Commissioner’s findings, arguing that the bank-deposits analyses overstated both the corporate and individual incomes and challenging the disallowance of numerous corporate deductions.

The amounts remaining in dispute following partial settlements were:

Corporate Income: Whether Lakeview underreported its gross income by $72,829 for 2015 and $110,016 for 2016.
Individual Income: Whether Armond must include an additional $9,621 in taxable income for 2015 and $21,065 for 2016.
Corporate Deductions/Losses: Disallowance of miscellaneous accruals ($222,218 for 2015 and $29,341 for 2016), advertising expenses ($7,233 for 2015 and $1,685 for 2016), “other deductions” ($4,002 for 2016), and a net operating loss (NOL) deduction ($171,332 for 2016).
Penalties: Whether Lakeview is liable for accuracy-related penalties.

Court’s Legal Analysis of Income and Accounting Methods

Authority for Income Reconstruction

The court confirmed that a taxpayer generally must follow their own accounting method, provided it clearly reflects income and is consistently followed (§ 446(a)). However, if the method does not clearly reflect income, the Commissioner has the discretion to determine the existence and amount of income using a reasonable method based on surrounding facts and circumstances (§ 446(b); RLC Indus. Co. & Subs. v. Commissioner, 98 T.C. 457, 491 (1992)). This latitude is substantial, particularly when a taxpayer fails to keep adequate books and records.

The accrual method requires taxpayers to report income in the year in which the "all events test" is met—meaning the right to receive income is fixed, and the amount can be reasonably determined (Treas. Reg. § 1.451-1(a)). This recognition occurs at the earliest of the date payment is received, due, or the date of contractual performance (Harkins v. Commissioner, 81 T.C.M. (CCH) 1547, 1550 (2001), citing Schlude v. Commissioner, 372 U.S. 128 (1963)).

When records are inadequate, the Commissioner may utilize a bank-deposits analysis, which assumes all money deposited into a taxpayer’s account during a period is taxable unless proven otherwise (e.g., inter-account transfers or loans) (§§ 6001, 446(b); Parks v. Commissioner, 94 T.C. 654, 658 (1990)). A valid bank-deposits analysis is treated as prima facie evidence of income (Tokarski v. Commissioner, 87 T.C. 74, 77 (1986)).

Conversion for Accrual Taxpayers

Since the bank-deposits method analyzes cash flow, the court stressed that an IRS agent conducting this analysis for an accrual-method taxpayer must make adjustments. The Internal Revenue Manual (IRM 4.10.4.6.4.6.2 (May 27, 2011)) outlines a procedure requiring the calculation of differences in accounts payable and accounts receivable balances at the beginning and end of the fiscal year. An increase in accounts receivable over the year increases an accrual-method taxpayer’s income, while an increase in accounts payable reduces income. These adjustments are crucial to avoid understating or overstating income (Olive v. Commissioner, 45 T.C.M. (CCH) 1249, 1264 (1983); Adler v. Commissioner, 27 T.C.M. (CCH) 480, 496 (1968)).

The burden generally rests on the taxpayer to prove the Commissioner’s notice of deficiency is incorrect (Welch v. Helvering, 290 U.S. 111, 115 (1933)). However, if the taxpayer can successfully undermine the bank-deposits analysis by demonstrating the inclusion of nontaxable deposits, the burden shifts back to the Commissioner to rehabilitate the analysis (Clayton v. Commissioner, 102 T.C. 632, 645–46 (1994)).

Application of Law to the Facts and Conclusions

Lakeview’s Corporate Income

The court agreed that the Commissioner’s use of the bank-deposits analysis was appropriate, finding that Lakeview’s corporate books were "wholly inadequate" and its accounting practices did not square with proper accrual accounting requirements. The court further found that the Commissioner’s Revenue Agent (RA) properly executed the analysis by conforming to the IRM’s accrual-conversion procedure, adding increases in accounts receivable and deducting increases in accounts payable, thereby yielding a clearer reflection of Lakeview’s income.

However, the court partially agreed with Lakeview’s challenge to the accuracy of the RA’s analysis regarding specific nontaxable deposits. Lakeview pointed to deposits from individuals (Armond, Arsen, Dr. Jauregui) and non-hospice sources (phone companies, City of Burbank). The court found it "more likely than not that the source of the deposits was not paying for hospice services," irrespective of whether the deposits represented loans, capital contributions, or small refunds. What mattered was that these amounts were not part of Lakeview’s taxable income.

Conclusion on Lakeview’s Income: The court found Lakeview’s specific additional adjustments for nontaxable deposits reasonable. The parties stipulated that these amounts were $89,543.85 for 2015 and $6,058.90 for 2016, and the court directed the parties to incorporate these adjustments in their Rule 155 computations.

Armond Garibyan’s Additional Income

Armond contested the additional income found through the bank-deposits analysis of his individual accounts, citing an unusual pattern of redeposits shortly after withdrawals. For example, the record showed a withdrawal from one account was redeposited in the same amount into another account on the same date.

Conclusion on Armond’s Income: The court agreed with Armond, finding it "more likely than not that these were simply transfers from one account to another, not taxable income". After accounting for a necessary subtraction related to previously conceded income, the court found in favor of the Garibyans on the disputed amounts of $9,621 for 2015 and $21,065 for 2016, concluding these sums were not additional taxable income.

Substantiation of Business Expenses

Taxpayers are required to keep adequate records to substantiate deductions for ordinary and necessary business expenses paid or incurred (§ 162(a); Hradesky v. Commissioner, 65 T.C. 87, 89–90 (1975)). The court sustained the Commissioner’s disallowance of nearly all disputed deductions:

Miscellaneous Accruals: The court sustained the disallowance of over $200,000 in miscellaneous accruals for 2015 and 2016, noting an "extreme lack of substantiation," as Lakeview failed to provide invoices, receipts, or similar documentation.
Advertising Expenses: The disallowance of advertising expenses for both years was sustained because the only supporting documentation consisted of handwritten expense reports lacking receipts or invoices. Further, these expenses appeared to have been paid to Arsen or one of his entities.
Other Deductions: Lakeview waived its right to contest the $4,002 in “other deductions” for 2016 by failing to address them in its opening brief (Stringer v. Commissioner, 84 T.C. 693, 704 (1985)).
Net Operating Loss (NOL): The $171,332 NOL deduction was disallowed because Lakeview failed to maintain books and records from the loss years necessary to substantiate a carryforward. A prior year’s return alone does not substantiate the loss claim (Lee v. Commissioner, 91 T.C.M. (CCH) 999, 1001 (2006); WB Acquisition, Inc. v. Commissioner, 101 T.C.M. (CCH) 1157, 1169 (2011)). Lakeview relied only on its previous returns and unreliable corporate ledger.

Accuracy-Related Penalties

The Commissioner sought accuracy-related penalties under § 6662(a) and (b)(1) and (2) for underpayments attributable to negligence or a substantial understatement. Lakeview asserted the defense of reasonable cause and good faith (§ 6664(c)). This defense requires the taxpayer to demonstrate they exercised ordinary business care and prudence regarding the disputed items (United States v. Boyle, 469 U.S. 241, 246 (1985)).

Conclusion on Penalties: Despite criticizing the Garibyans’ deficient bookkeeping, the court found that Lakeview met its burden to demonstrate reasonable cause. The key factors supporting the finding were that the Garibyans relied on two accounting professionals, one of whom advised the use of the accrual method and was found to be the source of the bizarre ledger entries that rendered the records unreliable. The court also acknowledged the complicating factor of "pass-through billing" inherent in the hospice industry. Finding by a preponderance of the evidence that Lakeview acted in good faith, the court concluded that Lakeview was not liable for accuracy-related penalties.

The ultimate result was deemed a mixed result, requiring decisions to be entered under Rule 155 to incorporate the court’s findings on income adjustments (corporate income reduced, individual income fully upheld for taxpayers) and the disallowance of all disputed deductions.

Prepared with assistance from NotebookLM.