The recent Tax Court memorandum opinion in Clinco v. Commissioner, T.C. Memo. 2026-16, serves as a stark warning to tax practitioners regarding two critical areas of practice: the fundamental requirement of substantiating deductions and income, and the emerging ethical peril of utilizing Artificial Intelligence (AI) in legal research without verification. Judge Holmes’s opinion not only addresses standard unreported income and depreciation issues but also delivers a blistering critique of a brief containing fictitious case citations likely generated by an AI model.

Factual Background

The case concerned the 2015 joint return of the late Peter Clinco, an attorney and entrepreneur, and his wife. Mr. Clinco operated a law practice and a restaurant, MedCafe Westwood, LLC, organized as a single-member LLC. On his Schedule C for MedCafe, Clinco reported gross receipts exceeding $1.6 million but claimed expenses resulting in a net loss of approximately $400,000. Additionally, Clinco reported rental real estate activity on Schedule E, claiming depreciation deductions for two properties in Pasadena, California.

Upon examination, the IRS Revenue Agent (RA) identified significant discrepancies between the reported gross receipts and credit card sales data. The RA utilized bank deposit analyses and third-party Information Return Processing (IRP) data—specifically Forms 1099-MISC and 1099-K—to reconstruct income. The RA determined a deficiency of nearly $2.3 million based on unreported receipts from sources including UCLA, American Express, and Grubhub, alongside an estimate of cash receipts derived from Mr. Clinco’s own admission that 10% of revenue was cash.

The "AI Soufflé": Validity of the Notice of Deficiency

A primary procedural argument raised by the petitioners was that the Notice of Deficiency was invalid because it lacked a "wet" signature from an IRS employee. The notice bore the name of a technical services territory manager followed by initials, indicating a delegated signing official.

In challenging the notice, the taxpayer’s counsel argued that "critical requirements like a signature must be followed for a Notice of Deficiency to be valid". To support this position, counsel cited several cases: Cacchillo v. Commissioner, Miller v. Commissioner, and Tefel v. Commissioner.

The Court’s analysis of these citations revealed a disturbing reality: the cases did not exist. Judge Holmes noted, "The persuasiveness of Clinco’s argument collapses like an overmixed soufflé when one looks at the citations used to prop it up.".

Regarding the specific citations, the Court observed:

"’Cacchillo v. Commissioner’ does not, however, exist. Page 132 in volume 130 of the Tax Court Reports is within Porter v. Commissioner... completely unrelated to the case before us."
The cited versions of Miller and Tefel were similarly fictitious. The Court stated, "The bouillabaisse of case names, reporter citations, and legal propositions suggests something cooked up by AI.".

The Court summarily rejected the argument on its merits as well, citing established precedent such as Tavano v. Commissioner, 986 F.2d 1389 (11th Cir. 1993) and the Internal Revenue Manual provisions allowing for digital or delegated signatures. Judge Holmes emphasized the severity of submitting fake citations, referencing Federal Rule of Civil Procedure 11(b) and warning that "Submitting a brief with fictitious caselaw is a recipe for sanctions.".

Unreported Gross Receipts and Reconstruction of Income

The substantive tax issue involved the Commissioner’s reconstruction of MedCafe’s income under I.R.C. § 446(b). The IRS relied on specific Forms 1099-MISC and 1099-K totaling over $2 million, plus estimated cash receipts.

The taxpayer attempted to rebut the presumption of correctness afforded to the Notice of Deficiency by arguing that the sources were unsubstantiated, that the IRS may have confused MedCafe with another restaurant ("Café Med"), and that certain deposits were actually capital contributions of personal funds.

The Court found the Commissioner’s reconstruction reasonable. The Court noted that the reconstruction relied on third-party data and the taxpayer’s own statements regarding cash percentages. Regarding the taxpayer’s claim that the deposits were capital contributions, the Court applied the burden of proof strictly. Although the RA had already conceded over $82,000 in substantiated capital contributions, the taxpayer failed to prove additional amounts. Judge Holmes held that "an email without more is not such a showing, so we cannot find the Commissioner incorrectly classified some capital contributions as income.".

Addressing the taxpayer’s defense regarding the business’s profitability, the Court succinctly ruled: "Clinco finally argues that MedCafe ‘never made a profit and had in fact been in bankruptcy.’ Even money-losing businesses, however, can have unreported income.".

Substantiation of Depreciation

The final issue concerned $56,798 in depreciation deductions claimed on Schedule E for two properties placed in service in May 2015. The taxpayer failed to provide purchase invoices, closing statements, or any records establishing the depreciable basis or the placed-in-service dates.

Instead, the taxpayer argued entitlement to the deduction on the grounds that the same depreciation allowance was claimed and not questioned in the 2017 tax year. The Court rejected this reasoning based on I.R.C. § 6001 and § 167(a). Citing Cluck v. Commissioner, 105 T.C. 324 (1995), the Court reiterated that taxpayers must prove basis, cost, and useful life. Judge Holmes concluded, "Whether Clinco claimed the deprecation in a later tax year is no proof he was entitled to the depreciation for 2015.".

Conclusion

The Tax Court upheld the deficiencies regarding the unreported income and disallowed depreciation, resulting in a decision to be entered under Rule 155.

For tax professionals, Clinco reinforces the necessity of rigorous substantiation for basis and income characterization. However, its most enduring lesson may be the ethical warning regarding legal research. As Judge Holmes cautioned, while the Tax Court has not yet sanctioned lawyers for AI hallucinations, "Their presence is unacceptable.". Practitioners must verify every citation, lest their arguments become, in the words of the Court, an "overmixed soufflé".

Prepared with assistance from NotebookLM.