MD M. Rahman & Syeda Momotaz v. Commissioner, Docket No. 8286-23 (T.C. Oct. 7, 2026) (Bench Op. by Nega, J.)

In MD M. Rahman & Syeda Momotaz v. Commissioner, Docket No. 8286-23 (T.C. Oct. 7, 2026), the United States Tax Court delivered a bench opinion under Tax Court Rule 152 providing critical practical guidance for tax practitioners representing sole proprietors under audit. Presided over by Judge Joseph W. Nega, the decision addresses core procedural and substantive tax issues: the Commissioner’s authority to reconstruct gross income via the bank deposits method under Internal Revenue Code (I.R.C.) § 446(b), the strict evidentiary limits of the Cohan rule for Schedule C expenses where records are alleged to have been destroyed, and the mandatory burden of production placed on the Service under I.R.C. § 7491(c) and I.R.C. § 6751(b)(1) regarding written supervisory approval for accuracy-related penalties.

This technical article analyzes the factual matrix, the procedural history, the statutory framework, the judicial reasoning, and the practical takeaways for CPAs and Enrolled Agents managing examination and litigation strategies.

Case Background and Factual Matrix

Petitioners, MD M. Rahman and Syeda Momotaz, were married taxpayers residing in Pennsylvania at the time their petition was filed. For the tax year 2019, petitioners timely filed a joint Form 1040 (U.S. Individual Income Tax Return) attaching a Schedule C (Profit and Loss from Business - Sole Proprietorship). During 2019, Mr. Rahman engaged in a wide array of entrepreneurial business ventures, including tax preparation, accounting services, insurance sales, travel agency-related services, immigration paperwork preparation, acting as a MoneyGram agent, retail cellular phone sales, taxi driving, and operating as an Uber driver.

On their original 2019 Schedule C, petitioners reported gross receipts or sales of $21,850 and claimed business expense deductions including $5,700 for repairs and maintenance, $4,500 for supplies, and $2,340 for meals.

The Internal Revenue Service selected petitioners’ 2019 return for examination. Because petitioners failed to maintain adequate books and records, the examining agent conducted an indirect income reconstruction utilizing a bank deposits analysis. The audit revealed total bank deposits of $81,378, which the IRS rounded down to $81,377 in the Notice of Deficiency issued on February 13, 2023. Subtracting the reported gross receipts of $21,850 resulted in a determined adjustment for unreported gross receipts of $59,527.

In the Notice of Deficiency for tax year 2019, the IRS determined a tax deficiency of $12,789, disallowed the claimed repairs and maintenance ($5,700) and meals ($2,340) deductions in full, limited the supplies deduction to $2,253 based on credit card substantiation, and asserted an accuracy-related penalty of $2,557.80 under I.R.C. § 6662(a). (Note: The IRS had also issued a Notice of Deficiency on January 27, 2023, determining deficiencies, I.R.C. § 6651(a)(1) additions to tax, and I.R.C. § 6662(a) penalties for tax years 2017 and 2018; however, on April 22, 2026, the Tax Court dismissed the 2017 and 2018 tax years for lack of jurisdiction because the petition was not filed within the 90-day statutory period prescribed by I.R.C. § 6213(a)).

During the audit, petitioners submitted a Form 1040-X (Amended U.S. Individual Income Tax Return), signed July 28, 2021, with a revised Schedule C reporting gross receipts of $59,027, repairs and maintenance of $1,101, supplies of $2,384, and $0 for meals. Petitioners filed their Tax Court petition on May 17, 2023. Prior to trial, on April 13, 2026, the parties filed a comprehensive Stipulation of Settled Issues resolving the majority of audit adjustments, leaving five specific issues for decision by Judge Nega at the trial held in Philadelphia, Pennsylvania on October 5, 2026.

Taxpayers’ Request for Relief and Disputed Issues

Petitioners sought full judicial relief from the Tax Court, requesting the disallowance of the determined $59,527 unreported income adjustment, full allowance of Schedule C deductions for repairs and maintenance, supplies, and meals, and complete abatement of the $2,557.80 I.R.C. § 6662(a) accuracy-related penalty.

Specifically, the five issues presented to the Court for decision were:

Whether petitioners underreported gross receipts or sales received by $59,527 for tax year 2019;
Whether petitioners were entitled to a Schedule C deduction for meals;
Whether petitioners were entitled to a Schedule C deduction for supplies in excess of $2,253;
Whether petitioners were entitled to a Schedule C deduction for repairs and maintenance; and
Whether petitioners were liable for the I.R.C. § 6662(a) accuracy-related penalty of $2,557.80.

To support their position, Mr. Rahman testified that his Schedule C business records were destroyed when his retail store was looted on June 1, 2020, and again on March 28, 2021. Regarding gross receipts, Mr. Rahman asserted that a $40,000 line of credit from American Express had inflated the bank deposit figures. Petitioners also contended that the figures submitted on their Form 1040-X reflected negotiated settlement terms agreed upon during the examination process rather than concessions of underlying liability.

Court’s Analysis of the Law

Judge Nega’s legal analysis systematically addressed the statutory standards, evidentiary thresholds, and burden-of-proof allocations governing income reconstruction, expense substantiation, and statutory penalty requirements.

Evidentiary Burden and Proof Allocation

Under Tax Court Rule 142(a) and well-settled precedent, the determinations made by the Commissioner in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving them erroneous (Welch v. Helvering, 290 U.S. 111, 115 (1933)). Furthermore, tax deductions are a matter of “legislative grace,” placing the burden squarely on the taxpayer to establish entitlement to any deduction claimed (Deputy v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934)).

While I.R.C. § 7491(a) allows the burden of proof to shift to the Commissioner if the taxpayer complies with substantiation requirements, maintains required records, and cooperates fully with reasonable IRS requests, Judge Nega noted that the resolution of this case did not depend on which party carried the burden of proof. Instead, the Court resolved the factual and legal issues based upon the “preponderance of evidence in the record” (Dagres v. Commissioner, 136 T.C. 263, 279 (2011)).

Unreported Income and the Bank Deposits Method

Gross income under I.R.C. § 61(a) encompasses “all income from whatever source derived” (Treas. Reg. § 1.61-2(a)(1)). Under I.R.C. § 446(b), where a taxpayer fails to maintain adequate books and records, the Commissioner is granted broad statutory authority to compute taxable income using a method that clearly reflects income (Cole v. Commissioner, 637 F.3d 767, 774–75 (7th Cir. 2011); Webb v. Commissioner, 394 F.2d 366, 371–72 (5th Cir. 1968); Factor v. Commissioner, 281 F.2d 100, 117 (9th Cir. 1960)).

The Tax Court reaffirmed that the bank deposits method is a long-recognized, legally permissible technique for reconstructing taxable gross income (Cole, 637 F.3d at 775; Clayton v. Commissioner, 102 T.C. 632, 645 (1994)). Established precedent dictates that bank deposits constitute “prima facie evidence of income” (Tokarski v. Commissioner, 87 T.C. 74, 77 (1986)). To support an income reconstruction based on bank deposits, the Commissioner must establish a reasonable link connecting the taxpayer to an income-producing activity (I.R.C. § 61(a)(1), (2); Walquist v. Commissioner, 152 T.C. 61, 67 (2019)).

Business Expense Substantiation and the Limits of Cohan

I.R.C. § 162(a) authorizes deductions for ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. An expense is “ordinary” if it is customary or normal in the taxpayer’s business, and “necessary” if it is appropriate or helpful (Commissioner v. Heininger, 320 U.S. 467, 471 (1943)). Conversely, I.R.C. § 262(a) strictly disallows deductions for personal, living, or family expenses.

Under the equitable doctrine established in Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir. 1930), if a taxpayer proves that deductible business expenses were paid or incurred but cannot substantiate the precise amount, the Court may estimate the allowable deduction. However, for a Cohan estimation to be applied, the record must contain sufficient credible evidence to allow the Court to form a rational basis for an estimate, ensuring that at least the allowed amount was actually expended (Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742–43 (1985)).

Mandatory Supervisory Approval for Penalties

In penalty determinations under I.R.C. § 6662(a), I.R.C. § 7491(c) explicitly places the burden of production on the Commissioner. As part of this statutory burden, the Commissioner must affirmatively demonstrate compliance with I.R.C. § 6751(b)(1), which mandates that no penalty shall be assessed unless the initial determination of such assessment is approved in writing by the immediate supervisor of the individual making such determination (Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017); Fumo v. Commissioner, T.C. Memo. 2025-97).

Application of the Law to the Facts

Applying these statutory provisions and judicial precedents to the evidentiary record, Judge Nega evaluated each of the five remaining issues.

Unreported Gross Receipts Adjustment Sustained

The Court found that respondent met the threshold burden of connecting petitioners to income-generating activities—namely, Mr. Rahman’s extensive array of Schedule C businesses. The burden then shifted to petitioners to demonstrate that the bank deposits represented non-taxable sources or transfers.

Mr. Rahman conceded during testimony that his books and records were imperfect and acknowledged that he routinely commingled personal funds, including his children’s income, with his business bank account. Regarding the claimed $40,000 American Express line of credit, petitioners failed to present documentary evidence or bank trace schedules demonstrating that loan proceeds accounted for the unexplained deposits. Expressing the central legal flaw in petitioners’ defense, Judge Nega ruled:

“Mr. Rahman honestly admitted that his books and records were not perfect, and even that he at times had commingled his children’s income with the business account. The Court is, likewise, unable to agree with Mr. Rahman’s argument that a $40,000 line of credit from American Express somehow resulted in an overstatement in petitioners’ 2019 gross receipts and sales. The absence of an adequate explanation by petitioners is fatal to their dispute. The Court, therefore, finds that petitioners understated their gross receipts by $59,527, as determined by the respondent in the notice of deficiency.”

Disallowance of Disputed Schedule C Expenses

Addressing the claimed deductions, the Court examined the evidentiary conflict surrounding petitioners’ original return, amended return, and trial testimony. While petitioners viewed their Form 1040-X as an attempted settlement offer, Judge Nega characterized the audit iterations as a “cooperative endeavor to ascertain the correct dollar amount for the disputed deductions.”

Mr. Rahman attributed the absence of receipts to store looting on June 1, 2020, and March 28, 2021. However, the Court identified a fatal logical inconsistency: petitioners managed to fully substantiate the numerous deductions agreed upon in the Stipulation of Settled Issues, yet provided zero substantiation or rational secondary evidence for the remaining disputed items (meals, repairs, and excess supplies). Rejecting petitioners’ plea for a Cohan estimate, Judge Nega stated:

“In his testimony, Mr. Rahman not only insisted that he should prevail entirely on all disputed deduction amounts, but he repeatedly explained petitioners total lack of documentation as a result of the looting of his store on June 1st, 2020, and March 28th, 2021. However, his testimony did not explain how then he was able to substantiate all the deductions allowed in the stipulation of settled issues and during the examination but none of the items that now remain at issue. His admission regarding his incomplete bookkeeping and his habit of paying personal expenses from his business account do not bolster his arguments. While his testimony is refreshing, it does not give the Court enough to apply a Cohan analysis.”

Consequently, the Court held that petitioners failed to substantiate any deduction for meals or for repairs and maintenance, and limited allowable supplies to the $2,253 previously stipulated.

Complete Abatement of the Accuracy-Related Penalty

On the final issue of the I.R.C. § 6662(a) penalty, the Court focused on the Commissioner’s statutory failure under I.R.C. § 6751(b)(1). The record contained no evidence of written supervisory approval for the initial penalty determination, and IRS counsel failed to raise or remedy the omission at trial. Judge Nega ruled:

“No supervisory approval appears in the documents submitted into evidence and respondent did not address the issue at trial. Respondent has not met his burden of production with respect to the accuracy-related penalty pursuant to 6662(a). Petitioners are, therefore, not liable for the accuracy-related penalty pursuant to 6662(a) with respect to tax year 2019.”

Judicial Conclusions and Key Takeaways for Tax Professionals

The Tax Court concluded its bench opinion by ordering that decision be entered under Tax Court Rule 155 to reflect the stipulated issues and the Court’s findings:

Unreported gross receipts of $59,527 are sustained in full.
Schedule C deductions for meals ($2,340) and repairs and maintenance ($5,700) are disallowed in full ($0 allowed).
Schedule C deduction for supplies is limited to $2,253 as stipulated.
The I.R.C. § 6662(a) accuracy-related penalty ($2,557.80) is denied in full due to respondent’s failure to meet the statutory burden of production under I.R.C. § 6751(b)(1) and I.R.C. § 7491(c).

For CPAs and Enrolled Agents representing clients under audit or in docketed Tax Court matters, Rahman provides three foundational practice notes:

Bank Deposits & Non-Taxable Source Tracing: When the IRS employs an indirect method of income reconstruction, general oral testimony asserting that deposits stemmed from loans (such as lines of credit) or non-taxable family transfers is insufficient. Practitioners must maintain bank statement schedules tracing specific loan disbursements directly into account deposits to defeat the IRS’s prima facie case.
Evidentiary Foundations for Cohan Estimates: Claiming casualty or property loss (e.g., store looting) as an explanation for missing records will not automatically unlock Cohan relief. If a taxpayer can substantiate certain items through third-party credit card records but fails to provide any secondary evidence (vendor logs, bank statements, or industry averages) for remaining expenses, courts will refuse to estimate deductions. Furthermore, commingling personal and business accounts undermines credibility.
Exploiting Procedural Defenses on Penalties: Practitioners must audit the IRS’s administrative case file for I.R.C. § 6751(b)(1) written supervisory approval. If the IRS fails to introduce the Civil Penalty Approval Form into evidence, the penalty must be defeated under I.R.C. § 7491(c), regardless of the underlying understatement of tax.

Prepared with assistance from Gemini Notebook.