For tax professionals representing clients with commingled funds and unfiled returns, the recent Tax Court decision in Chernomordikov v. Commissioner, T.C. Memo. 2025-129, offers a critical examination of the bank deposits method, the substantiation of Cost of Goods Sold (COGS), and the high evidentiary bar required to sustain fraudulent failure to file penalties. While the court sustained the majority of the deficiencies based on the taxpayer’s lack of records, the decision regarding the fraud penalty provides a nuanced look at how the "missing witness" rule applies when a tax preparer fails to testify.

Factual Background

The case concerns Mark and Jessica Chernomordikov for the tax years 2012 through 2014. Mr. Chernomordikov managed ONY Sales, Inc., an online electronics retailer formerly owned by his late stepfather and mother. Although he was not a shareholder during the years at issue, Mr. Chernomordikov exercised complete control over the business finances. The court noted that he treated the corporate funds as his own, using them to purchase luxury vehicles, including a Lamborghini, a Ferrari, and a Rolls Royce, and to fund personal real estate transactions.

Mr. Chernomordikov engaged Melvin Lee and Golden Bay Tax & Bookkeeping Services for tax preparation. Mr. Lee, a former IRS Revenue Agent, was later investigated by the IRS Criminal Investigation Division. Despite earning substantial income through his use of corporate funds, Mr. Chernomordikov did not file personal income tax returns for 2012 through 2014, nor did he make estimated tax payments.

Upon examination, the IRS utilized the bank deposits method to reconstruct income, determining millions of dollars in unreported income for both Mr. Chernomordikov and his wife (who was relieved of liability for 2012 and 2014 prior to trial). The IRS asserted deficiencies and additions to tax for failure to file, failure to pay, failure to make estimated tax payments, and the onerous fraudulent failure to file penalty under I.R.C. § 6651(f).

Burden of Proof and Unreported Income

The court began its legal analysis by addressing the burden of proof. Generally, the taxpayer bears the burden of proving a deficiency is erroneous. However, in unreported income cases, the Ninth Circuit (to which this case is appealable) requires the Commissioner to first establish an evidentiary foundation linking the taxpayer to the income-producing activity. Weimerskirch v. Commissioner, 596 F.2d 358, 361 (9th Cir. 1979).

The court found the IRS satisfied this threshold through the bank deposits analysis connecting Mr. Chernomordikov to ONY Sales. The burden then shifted back to the petitioners. Under I.R.C. § 61(a), gross income includes "all accessions to wealth over which the taxpayer has complete control". The court emphasized that a taxpayer has control "when the taxpayer is free to use the funds at will" and that "[t]he use of funds for personal purposes indicates dominion and control, even if these funds are in an account titled in a name other than the taxpayer’s".

Applying the law to the facts, the court rejected the petitioners’ argument that the accounts belonged solely to the corporation. The judge cited Mr. Chernomordikov’s own testimony where he admitted he " ‘didn’t really feel like there was a difference’ between ONY Sales’ bank accounts and his personal bank accounts". Consequently, the court accepted the IRS’s reconstruction of income as reasonable, noting that "Bank deposits constitute prima facie evidence of income... and the bank deposits method is a permissible method of reconstructing income".

Substantiation of Cost of Goods Sold

The petitioners attempted to offset the reconstructed income by claiming Cost of Goods Sold (COGS). The court reiterated the fundamental requirement that any amount claimed as COGS must be substantiated under I.R.C. § 6001.

Mr. Chernomordikov argued that he dealt in cash to satisfy suppliers and was merely following his stepfather’s business practices. The court found this insufficient, stating: "His explanation that he was simply following the practice of his late stepfather and complying with suppliers’ requests to deal in cash cannot substitute for actual evidence".

Furthermore, the court refused to apply the Cohan rule to estimate expenses. The court noted that latitude to estimate "requires more support than petitioners have offered, especially when Mr. Chernomordikov admitted at trial that he used funds in ONY Sales’ accounts for his personal expenses".

Stipulations Regarding Filing Status

A procedural highlight of the case involved the petitioners’ filing status for 2013. Generally, taxpayers may only secure joint filing status by actually filing a joint return. See I.R.C. § 6013(a). Since the Chernomordikovs filed no returns, they would typically be barred from joint rates.

However, the parties had executed a Stipulation of Settled Issues stating the petitioners were "entitled to ‘married filing jointly’ filing status for the 2013 tax year". In post-trial briefs, the IRS attempted to argue for "married filing separate" status. The court rebuked this attempt, citing Tax Court Rule 91(e). The Judge held: "He offered no reason as to why we should relieve him of the binding effect of the parties’ Stipulations settling this issue.... We therefore will hold him to it: Petitioners are entitled to married filing jointly status for 2013".

The Fraud Penalty and the Missing Witness

The most significant legal analysis in the opinion concerns the addition to tax for fraudulent failure to file under I.R.C. § 6651(f). This penalty requires the Commissioner to prove fraudulent intent by clear and convincing evidence.

The IRS relied on several "badges of fraud," including the failure to file over multiple years, dealing in cash, and inadequate records. The IRS also argued that the court should draw a negative inference from the petitioners’ failure to call their tax preparer, Mr. Lee, as a witness, citing Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158 (1946).

The court rejected this inference. The judge noted that the IRS had also listed Mr. Lee as a witness but chose not to call him. "Thus, Mr. Lee may have been available to both sides but neither chose to call him. Against this backdrop we do not believe any presumptions can or should be drawn about Mr. Lee’s hypothetical testimony".

Ultimately, the court ruled that the IRS failed to meet the clear and convincing standard. The court distinguished Mr. Chernomordikov’s lack of sophistication from cases involving tax professionals, such as Fiore v. Commissioner, T.C. Memo. 2013-21. The court explicitly noted that the IRS’s failure to call the tax preparer was fatal to their fraud case: "Respondent’s failure to call Mr. Lee leaves a hole in respondent’s proof of fraud by clear and convincing evidence that we cannot fill with an inference, particularly in the light of Mr. Chernomordikov’s lack of education and experience".

Additions to Tax for Failure to File and Pay

While the fraud penalty was not sustained, the court upheld the standard additions to tax under I.R.C. § 6651(a)(1) (failure to file) and § 6651(a)(2) (failure to pay).

The taxpayers attempted to argue reasonable cause based on reliance on their agent, Mr. Lee. The court rejected this, citing United States v. Boyle, 469 U.S. 241 (1985). The opinion states: "The failure to make a timely filing of a tax return is not excused by the taxpayer’s reliance on an agent, and such reliance is not ’reasonable cause’ for a late filing... [a]t the least he should have asked questions".

Regarding the failure to pay, the court noted that Mr. Chernomordikov "knew he paid Mr. Lee and Golden Gate a percentage of his tax savings for their advice... He may complain now that Mr. Lee was a bad actor, but he cannot hide behind the bad advice and Mr. Lee’s absence from trial to establish reasonable cause".

Estimated Tax Penalties

The court also sustained penalties for failure to pay estimated tax under I.R.C. § 6654.

For 2012: The court calculated the required annual payment based on Mr. Chernomordikov’s 2011 return, which showed a liability of only $1,147. Thus, the penalty is based on that lower "safe harbor" amount rather than 90% of the massive 2012 deficiency.
For 2013: Because no 2012 return was filed, the "prior year tax" safe harbor was unavailable. The penalty was calculated based on 90% of the 2013 tax liability.

Conclusion

Chernomordikov serves as a stark reminder that while the IRS faces a high hurdle in proving fraud—specifically requiring clear and convincing evidence of intent—taxpayers remain vulnerable to substantial deficiencies and negligence penalties when they fail to maintain records or file returns.

To understand the court’s treatment of the fraud penalty versus the deficiency, consider the difference between a person who drives a car with a broken speedometer and one who disconnects it on purpose. The deficiency and negligence penalties punish the driver for the speeding itself and the failure to maintain the equipment (the lack of records and filing). However, the fraud penalty requires proof that the driver disconnected the cable to intentionally deceive the police. In this case, without the testimony of the mechanic (the tax preparer) to prove exactly what instructions were given, the court refused to assume the driver was acting with malicious intent, even if his driving was reckless.

Prepared with assistance from NotebookLM.