For tax professionals, the requirement to maintain adequate books and records under Internal Revenue Code (IRC) section 6001 is foundational. However, when a fellow practitioner fails to adhere to these standards, the resulting litigation offers a stark reminder of the judicial application of the bank deposits method and the doctrine of dominion and control. In the recent case of Algarawi v. Commissioner, T.C. Memo. 2026-8, the United States Tax Court addressed the tax liability of a prolific tax return preparer who commingled business receipts, alleged charitable donations, and personal funds, ultimately sustaining the IRS’s deficiency determinations and accuracy-related penalties.

Background and Facts

The petitioners, Jabir Algarawi and Amira Hachim, resided in Arizona and filed joint returns for the tax years 2020 and 2021. Mr. Algarawi wore multiple hats: he was a real estate broker, the president of the Arizona Allnation Refugee Resource Center (Allnation), and the sole proprietor of Ali Tax Income. His tax practice was substantial, preparing "1,294 returns in 2020 and 1,953 returns in 2021".

Despite this volume, Mr. Algarawi’s record-keeping practices were nonexistent. He operated a "donation box" outside his office where he encouraged clients—specifically refugees—to donate to Allnation in lieu of, or in addition to, payment. Critically, Mr. Algarawi "did not keep records of the cash deposits, nor did he give the donors receipts". Furthermore, he solicited funds via Facebook for families in need, receiving payments through a Zelle account linked to his personal phone number.

All funds—whether intended for Allnation or his proprietorship—were deposited into Mr. Algarawi’s personal bank account; Allnation did not maintain a separate account. On their Schedules C, the petitioners reported gross receipts of only $12,548 for 2020 and $12,458 for 2021.

Following an examination, the IRS utilized a bank deposits analysis. The revenue agent determined that the petitioners underreported gross receipts by $72,130 for 2020 and $93,614 for 2021. Additionally, the IRS identified unreported cancellation of debt (COD) income of $5,615 from Citibank for the 2020 tax year.

Evidentiary Rulings on Untimely Documentation

A preliminary issue concerning the admissibility of evidence highlights the importance of adhering to the Tax Court’s Standing Pretrial Order. The petitioners attempted to introduce letters (Exhibits 22-P through 27-P) from community members attesting to Mr. Algarawi’s charitable acts and free services. The Court excluded these documents because they were not exchanged at least 14 days before trial.

The Court emphasized that "the rule prevents an ‘ambush’ with last-minute evidence that could have been presented to the opposing party during preparation for trial". Furthermore, the Court noted that even if admitted, the documents constituted hearsay with no applicable exception, and ultimately, "would not help us resolve the issue that we must decide here: whether the deposits into petitioners’ accounts identified in the bank deposits analysis were taxable income to petitioners".

Unreported Income and the Bank Deposits Method

The substantive dispute centered on whether the bank deposits constituted taxable gross income under section 61(a). The Court reiterated that when a taxpayer fails to maintain adequate books and records, the IRS is authorized to compute income by any method that clearly reflects income, specifically noting that "[b]ank deposits are ’prima facie evidence of income’" (citing Tokarski v. Commissioner, 87 T.C. 74, 77 (1986)).

Once the IRS established an evidentiary foundation connecting the taxpayer to the income-producing activity via the bank deposits analysis, the burden shifted to the petitioners to prove the determination erroneous.

Rejection of the "Conduit" Theory

Mr. Algarawi argued that the funds were not income but rather charitable contributions he collected as an intermediary to assist families in need. This argument implicates the doctrine of dominion and control. Income includes "deposits into all accounts over which the taxpayer has dominion and control" (citing Chambers v. Commissioner, T.C. Memo. 2011-114).

To succeed on a "conduit" theory—arguing that he was merely a pass-through entity for the funds—Mr. Algarawi needed to provide specific evidence tying deposits to payouts. The Court found the record lacking, stating: "Aside from the letters discussed above, written years after the deposits being questioned, he offers no evidence tying specific deposits to the ultimate recipients".

Without contemporaneous records tracing the funds, the Court could not separate taxable income from alleged pass-through gifts. The Judge ruled: "With no evidence showing which deposits were passed along, we cannot conclude on this record that Mr. Algarawi did not have dominion and control over any particular deposits". The Court further noted that Allnation, the organization for which he allegedly collected funds, did not have tax-exempt status or a separate bank account to validate the nature of the funds.

Discharge of Indebtedness Income

Regarding the $5,615 in COD income, Mr. Algarawi’s defense was limited to the claim that he did not receive a Form 1099-C. The Court dismissed this argument, citing Rinehart v. Commissioner, T.C. Memo. 2002-71: “nonreceipt of a Form 1099 does not convert taxable income into nontaxable income”. As no section 108(a) exclusions were alleged, the deficiency was sustained.

Late-Raised Arguments Denied

In a post-trial letter, the petitioners attempted to submit unsigned amended returns and claim COVID-19 related sick and family leave credits. The Court refused to consider these issues, relying on Rule 34(b)(1)(G), which deems issues not raised in the petition as conceded. The Court noted that admitting such evidence post-trial would prejudice the respondent, who "could not examine or question the evidence as he might have at trial".

Accuracy-Related Penalties

The Court upheld the section 6662(a) penalties for substantial understatement of tax and negligence. The IRS met its burden of production by showing the understatements exceeded the greater of 10% of the tax required or $5,000, and by providing written supervisory approval for the penalties.

The burden then shifted to the petitioners to show reasonable cause. The Court found the reasonable cause defense particularly weak given Mr. Algarawi’s profession. The opinion states: "Mr. Algarawi is a paid tax return preparer, having prepared over 3,000 tax returns during 2020 and 2021. Yet he kept no record of the alleged charitable contributions and did not maintain any (much less adequate) books and records for Ali Tax Income".

Conclusion

Algarawi v. Commissioner serves as a cautionary tale regarding the necessity of distinct separation between business, personal, and charitable funds. The Tax Court affirmed that "gaps in petitioners’ proof, especially given Mr. Algarawi’s occupation as a paid tax return preparer, sink their arguments". For practitioners, the case reinforces that the bank deposits method remains a formidable tool for the IRS, and overcoming it requires contemporaneous, specific documentation—not after-the-fact reconstruction or testimonial assertions of charitable intent.

Prepared with assistance from NotebookLM.