The opinion
United States Tax Court
T.C. Memo. 2025-105
ARMOND GARIBYAN, ET AL., 1
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket Nos. 7835-20, 7836-20, Filed October 9, 2025.
7837-20, 7741-21.
—————
Aksel Bagheri, for petitioners.
Joanne H. Kim, Sharon Y. Tang, and Jordan S. Musen, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HOLMES, Judge: Armond and Arsen Garibyan are brothers who
started Lakeview Hospice Care, Inc. The hospice business depends for
its income almost entirely on third parties, usually private and public
insurers. The Garibyans adopted the accrual method of accounting for
Lakeview’s books. Their problem is that Lakeview’s corporate ledger
rarely showed income and expenses as they accrued during the year.
The Commissioner audited Lakeview’s and then the Garibyans’
individual returns. He combed through their bank records for the 2015
and 2016 tax years and concluded that Lakeview had underreported its
gross income by more than $200,000; and that Armond underreported
his income for both years too. 2 The parties also dispute the
1 We consolidated Arsen Garibyan, Docket No. 7836-20, Lakeview Hospice
Care, Inc., Docket No. 7837-20, and Armond Garibyan and Ani Garibyan, Docket No.
7741-21, with this case.
2 The Commissioner and Arsen settled their differences.
Served 10/09/25
2
[*2] Commissioner’s disallowance of more than $450,000 in deductions
for Lakeview.
Lakeview and the Garibyans say these bank deposits analyses
overstate their income. They also contest the disallowance of Lakeview’s
deductions.
FINDINGS OF FACT
I. Lakeview’s Origins
A high school graduate who dropped out of college, Armond
Garibyan was what he describes as a “glorified life insurance agent” in
a past life, although he was in fact licensed as an insurance agent by
California’s Department of Insurance. He also held officer and board
positions with five California business entities, including a barber shop
and various marketing and consulting companies.
Armond’s younger brother, Arsen, also has a background in the
insurance business. He was a licensed insurance agent in California
and worked for Ellion Financial and Insurance Services, Inc. He was
also a serial entrepreneur, who co-owned the barber shop and was a
shareholder and officer in two other California corporations unrelated
to the hospice industry.
In 2008, Armond started talking to a neighbor who was a
consultant for the hospice industry, and they hit it off because Armond
himself had an interest in healthcare. Shortly thereafter, Armond and
Arsen founded Lakeview as a California C corporation. 3
Lakeview’s office is in Burbank, California. Armond is
Lakeview’s administrator and oversees its payroll expenses and staffing.
He also deals with Medicare and the various regulatory agencies that
oversee the hospice industry. Arsen runs the firm’s marketing
department. Armond married his wife, Ani, in 2016 and brought her
into the business. Both Armond and Ani as well as Arsen reside in
Glendale, California.
3 A “C corporation” is a corporation that is taxed under subchapter C of
chapter 1 of the Internal Revenue Code, sections 301–385. (Unless otherwise
indicated, statutory references are to the Internal Revenue Code, Title 26 U.S.C.
(Code), in effect at all relevant times, regulation references are to the Code of Federal
Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and Rule references
are to the Tax Court Rules of Practice and Procedure.)
3
[*3] Lakeview’s business was closely tied to employees outside of the
Garibyan family, though. Dr. Nicholas Jauregui was a 51-percent
shareholder of Lakeview by way of Kephas MSO, which was one of the
corporations that he controlled and that received payments from
Lakeview. He was also Lakeview’s medical director. (California
requires hospices to have medical directors.) In this role, Jauregui
oversaw all clinical operations because Lakeview’s other employees
didn’t deal directly with patients’ doctors. Jauregui signed off on all the
patients’ clinical orders.
Two other Lakeview employees, a husband-and-wife team, helped
bring in new patients. But in late 2014, they left Lakeview and started
their own hospice agency. Lakeview lost patients and revenue. There
was real doubt about whether it would survive.
But this case is about the dry bones of tax accounting, and if we
are to reanimate them, we must first explain how the for-profit hospice
industry works in California.
II. The Hospice Business
Hospice agencies care for terminally ill patients. California
requires hospice agencies to be licensed by the California Department of
Public Health, which requires an application and a site visit to the
hospice center.
Lakeview itself needed to complete what Armond described as a
two-step application process. In 2008 he rented an office for his
administrative staff and submitted an application to the local health
department. Then he had to submit a license application to Medicare,
which issued him a provider number allowing Lakeview to bill for
patient reimbursement. Waiting for his health-department license and
Medicare provider number took Lakeview five years after its 2008
incorporation. And that meant five years before it could begin receiving
reimbursements.
A hospice agency must not only be licensed by California, it must
also be certified and contract with insurance providers to be reimbursed
for its services. Neither hospice patients nor their families pay for
hospice care. Hospice agencies depend for their income on insurers:
Medicare (the federal program which is the largest payor of hospice
services nationwide), Medi-Cal (California’s Medicaid program for the
poor), and patients’ private insurers.
4
[*4] Like many industries with overlapping government and third-
party involvement, the feds’ procedures dictate much of how hospice
businesses operate. The U.S. Centers for Medicare and Medicaid
Services must verify that an agency meets its requirements before
Medicare money can flow. These include certifying that a patient is
“terminally ill,” which is a determination made by a physician. 4 Each
determination lasts 90 days but can be renewed. A hospice that cares
for a certified patient can then receive daily rates while that patient is
in its care.
These were the federal daily rates in the Los Angeles area during
the years at issue: 5
Routine Routine Home Inpatient General
Continuous
Tax Home Care Care (per Day) Respite Inpatient
Home Care
Year (per Day) Days 61 and Care (per Care (per
(per Hour)
Days 1–60 Beyond Day) Day)
2015 $187.07 — — $187.41 $823.69
2016 217.96 171.29 $45.92 189.42 831.84
Medi-Cal used similar daily rates but allowed patients to be
certified at six-month intervals. In California, hospice patients can have
both Medicare and Medi-Cal. Medi-Cal pays for room and board at
nursing homes and similar facilities, which Medicare does not. And
patients without Medicare or Medi-Cal must pay for hospice care and
room-and-board expenses by themselves, typically with private health
insurance.
Hospice agencies such as Lakeview do not typically provide a
physical location for their patients. Many of Lakeview’s patients, for
example, live in nursing homes or similar institutions. Once a patient
is certified as terminally ill, the institution is no longer allowed to bill
insurers directly. They must instead start “pass-through billing,” which
means the nursing facility bills the hospice agency for a patient’s room-
and-board expenses. Agencies like Lakeview then bill the insurer—
Medi-Cal or a private insurance company—for these expenses. The
hospice agency then has to reimburse the nursing facility.
4 When electing to receive hospice care under such a certification, patients are
foregoing treatment of their terminal illness and certifying that Medicare will no
longer pay for their treatment.
5 When the daily rates were not available in the record, we used an em dash.
5
[*5] This meandering cashflow can take a while to reach its
destination. And that’s not the only cashflow problem hospice agencies
must solve. Agencies such as Lakeview typically receive a fixed daily
payment for their patients, out of which they must pay variable patient
expenses such as medication, medical equipment, nurses, chaplains,
social workers, and therapists. While there are some economies of scale
to be had by an agency’s formulary deal with a pharmacy for
medications, a hospice agency that spends more on a patient than it
receives from these daily rates will lose money. One can easily see why
accurately tracking reimbursements and expenses is crucial to a hospice
business’s survival.
III. Lakeview’s Accounting
A. Patient Data Entry
Lakeview received income from only Medicare, Medi-Cal, and
private health-insurance companies; none of its patients paid out-of-
pocket for their care. And much of its Medi-Cal income came in the form
of reimbursements to nursing homes for room and board. All of these
reimbursements, medical care, and employees require copious data
keeping.
When a patient was first referred to Lakeview, it received the
patient’s demographic information from the referring physician. Then
its intake department formally requested the patient’s medical records
and inputted the patient’s insurance and previous medical information
into its system. A Lakeview nurse then assessed the patient and
updated the medical records according to the assessment.
B. Consolo and EHP Billing
To keep track of all this essential data Lakeview subscribed to an
electronic health records program called Consolo. This program
assigned a unique medical record number for each patient. Lakeview’s
nurses and intake specialists inputted all patients’ medical records,
billing, revenue, and HIPAA 6 compliance information into Consolo.
6 The Health Insurance Portability and Accountability Act of 1996 (HIPAA),
Pub. L. No. 104-191, §§ 261–264, 110 Stat. 1936, 2021–34, contains privacy rules and
gave rise to privacy regulations relating to individually identifiable health
information.
6
[*6] Lakeview was assigned a representative at Consolo who generated
monthly reports that detailed its patient and revenue data.
Consolo played a critical role in Lakeview’s billing process.
Lakeview contracted with EHP Billing (EHP), a third-party billing
service, to provide invoices for Lakeview and bill insurance companies
for Lakeview’s services and its passthrough billing for nursing homes.
Because EHP also runs on the Consolo platform, it was able to bill in
compliance with HIPAA using Lakeview’s Consolo data. Neither EHP,
Armond, nor anyone else at Lakeview could alter Consolo’s billing rates
once they were entered into the program.
Lakeview paid Consolo a small percentage of its revenue to
license the software. EHP also got a cut—it received 2% of what
Lakeview billed to the government and insurance companies, with a cap
of $5,000 a month. EHP itself could face a regulatory slap from Medicare
if it found Lakeview wasn’t billing the government correctly. The
Garibyans argue that these incentives make EHP’s and Consolo’s
records reliable enough that we should use them to compute Lakeview’s
gross revenue or, at the very least, an alternative source of information
to derive Lakeview’s income other than what they say is the
Commissioner’s flawed bank-deposits analysis.
C. Lakeview’s Ledger
Lakeview’s use of Consolo and EHP seems to fall in line with the
industry standard. But Lakeview’s own internal recordkeeping is a
different story. Only Armond and Arsen had authority to sign checks on
behalf of Lakeview, but in practice Armond wrote and signed all the
checks.
From its inception in 2008, Lakeview used Channels & Channels,
Inc., an accounting firm located in the Orange County community of
Costa Mesa, as its outside bookkeeper. Ron Channels, the firm’s
president, has more than 60 years of tax-preparation experience, but he
isn’t a CPA. He helped Armond set up Lakeview’s bookkeeping system,
although he didn’t give Armond any advice on how to maintain books for
a hospice business in particular.
He did, however, advise Lakeview to keep its books on an accrual
system. An accrual-method taxpayer recognizes income when it is
earned. See Martin v. Commissioner, 121 T.C.M. (CCH) 1237, 1241
(2021). Lakeview’s fiscal year ran from October 1 through September
30.
7
[*7] The Garibyans argue that Lakeview’s general ledger follows the
rule of accrual accounting. Entries are divided into debits or credits,
and include the name of the vendor or payor, the date, and the amount
of payment. But Lakeview’s ledger also contained some oddities. At the
beginning of its 2016 fiscal year, Lakeview reversed its accounts
receivable from $110,975 to $0 without intervening entries to account
for the reversal. And it rarely debited accounts receivable every
month—if at all—despite regularly receiving payments from insurance
companies via EHP.
And then there was Armond’s process for actually keeping track
of the figures that needed to be put in the ledger. When Lakeview
received an invoice, he stamped the invoice as paid, dated it, and put it
in a manila folder. Armond described this system as simple yet suitable
because he could keep track of Lakeview’s relatively small number of
vendors. Armond scanned and emailed or physically delivered the
invoices to Channels for him to keep Lakeview’s books.
But whatever Armond and Channels were doing did not lead to
an understandable ledger for Lakeview. There were a large number of
adjusting journal entries in Lakeview’s general ledger between its two
accounts payable. 7 As an example, Lakeview reversed $106,490 in one
of its accounts-payable balances in 2016 by just writing “Journal Entry”
and “Reverse of Year End Accruals” in the ledger. We found more than
a dozen similar journal entries for that year.
The deficiencies in Lakeview’s accounting would ultimately lead
the Commissioner to analyze the firm’s cash deposits and transfers in
its bank accounts. There were three of these, all at Wells Fargo (WF).
Armond and Arsen used one of these, WF #1732, primarily to track and
pay Lakeview’s expenses. A second, WF #1740, tracked Lakeview’s
income. The last WF account had minimal activity, and the parties
agree that it received no taxable deposits during the years at issue.
7 An adjusting journal entry is “[a]n accounting entry made into a subsidiary
ledger called the General journal to account for a period[’s] changes, omissions or other
financial data required to be reported ‘in the books’ but not usually posted to the
journals used for typical period transactions.” Ernest S. Ryder & Assocs., Inc., APLC
v. Commissioner, 122 T.C.M. (CCH) 25, 34 n.23 (2021) (quoting Accounting
Terminology Guide, New York State Society of CPAs,
https://www.nysscpa.org/professional-resources/accounting-terminology-
guide#sthash.OMJATGaN.BomMsjPI.dpbs (last visited Aug. 21, 2025)).
8
[*8] IV. Preparation of Tax Returns
A. From Channels to Abedian
From its start in 2008 until 2016, Lakeview used Channels to help
keep its books as well as prepare its tax return. Lakeview switched to
Emil Abedian of Abedian & Totian, AAC, to prepare its 2016 tax return.
Abedian is a licensed California CPA, and he relied on Lakeview’s books
as Channels had prepared them for that year.
The reason for the switch was one that all Southern Californians
can appreciate. Lakeview, the Garibyans, and Abedian were in
Glendale, and Channels was all the way down the 405 in Costa Mesa.
And, as we learned, Lakeview’s unique accounting practices often
required one of the Garibyans to make the long drive and deliver to
Channels a cache of envelopes and documents to do the company’s books.
After nine years, Armond was understandably tired of making the drive.
B. The 2015 Returns
For 2015, Channels tallied the ledger and reported $1.9 million in
gross receipts on Lakeview’s Form 1120, U.S. Corporation Income Tax
Return. But he offset that with cost of goods sold and $1.8 million in
deductions, including officer compensation, salaries and wages,
advertising, and almost $500,000 in “other deductions.” Lakeview thus
reported a loss of more than $270,000.
Armond himself reported $84,290 in salary—$78,790 of which
was from Lakeview—on his 2015 return. He offset it with $67,602 in
other losses that he now stipulates should have been included as “Other
Income–Line 21” on his return rather than as losses. He filed as an
individual, as he hadn’t yet married Ani. Channels also prepared this
return.
C. The 2016 Returns
For the 2016 tax year, Abedian was faced with transitioning
Lakeview and the Garibyans from Channels’s unusual bookkeeping and
tax preparation to his own. Abedian received an electronic copy of the
QuickBooks ledger that Channels had prepared and transferred it to his
program, checking it to make sure it seemed “reasonable”—which he
deemed it was. He did make some entries and adjustments to
Lakeview’s general ledger, though, including backing out a deduction for
9
[*9] deferred payroll 8 that he noticed wasn’t paid and increasing the
firm’s profit after noticing a portion of the accounts payable wasn’t paid
the next year. He then made another $140,000 adjusting journal entry
to split out wages from accounts payable.
Abedian reflected these changes on Schedule L, Balance Sheets
per Books, on Lakeview’s 2016 return, reporting $490,840 in wages paid.
The company reported $1.08 million in gross income, $909,629 in total
deductions, and a $171,332 net operating loss.
On their first joint return, which Channels prepared, Armond and
Ani reported $77,104 in total income. Much of this came from Ani’s
wages, as she was still working at a bank in 2015 and 2016 before she
joined Lakeview. The couple attached a W-2 form that reported $467 in
wages from Lakeview but offset most of this with “other losses” on their
return.
V. Audit and Trial
The Commissioner began looking into Lakeview because he
noticed that it didn’t deduct officer compensation in 2016 and took lots
of uncategorized deductions. His revenue agent (RA) sent the company
a letter asking it to identify a responsible person who could testify and
produce books and records. Lakeview sent a profit-and-loss statement,
a copy of its general ledger, bank statements from its two active WF
accounts, its Forms 1099, and a copy of its bylaws.
After receiving and reviewing these, the RA and her manager met
Armond and his representative at Lakeview’s office. She learned about
the business and how Armond made payments and deposits. With this
information and the documents that Lakeview provided, the RA tried to
reconcile Lakeview’s profit-and-loss statements to the line items on its
2016 return.
She next reviewed Lakeview’s general ledger. She found that the
company wasn’t recognizing income on a monthly basis in its accounts
receivable despite issuing monthly invoices to Medicare, Medi-Cal, and
private insurers. She also noticed irregularities in how entries were
booked to the accounts receivable and accounts payable and decided to
conduct a bank-deposits analysis. This is a method of income
8 Abedian testified that, in his opinion, deferred compensation should be
treated as a liability and not in the accounts-payable section of an accrual-based ledger
as had been done by Channels.
10
[*10] reconstruction that the Commissioner may use when the taxpayer
fails to provide accurate records. See §§ 6001, 446(b); Parks v.
Commissioner, 94 T.C. 654, 658 (1990). It assumes all money deposited
into a taxpayer’s bank account during a period is taxable except for
deposits that are transfers between accounts or that the agent concludes
are otherwise nontaxable. Courts treat a valid bank-deposits analysis
as prima facie evidence of income. See Tokarski v. Commissioner, 87
T.C. 74, 77 (1986).
A bank-deposits analysis is necessarily a cash analysis, and an
IRS agent who conducts such an analysis of the deposits of an accrual-
method taxpayer has to make adjustments. So the Internal Revenue
Manual (IRM) has a procedure to adjust a bank-deposits analysis for an
accrual-method taxpayer. 9 In this method, see IRM 4.10.4.6.4.6.2 (May
27, 2011), the key is for the RA to figure out the differences in both
accounts payable and accounts receivable at the beginning and the end
of each fiscal year. Any increase in accounts receivable over the course
of the year increases an accrual-method taxpayer’s income; an increase
in accounts payable over the course of the year reduces an accrual-
method taxpayer’s income. It’s important for an RA to make these
adjustments to avoid an understatement or overstatement of income.
See Olive v. Commissioner, 45 T.C.M. (CCH) 1249, 1264 (1983), aff’d,
749 F.2d 32 (4th Cir. 1984) (unpublished table decision); Adler v.
Commissioner, 27 T.C.M. (CCH) 480, 496 (1968), aff’d, 422 F.2d 63 (6th
Cir. 1970).
Following concessions, here are the adjustments in Lakeview’s
notice of deficiency that are still at issue:
Tax Adjustment Amount Per Adjustment in Amount in
Year Category Return SNOD Dispute
Gross receipts or
$1,896,130 $132,356 $132,356
sale
2015 Misc. expenses
1,875,127 222,218 222,218
(year-end accruals)
Advertising 14,068 7,233 7,233
9 The agency’s internal policies as reflected in the IRM don’t have the force of
law but can be instructive and persuasive authority. See Gurule v. Commissioner, 109
T.C.M. (CCH) 1315, 1321 n.9 (2015).
11
[*11]
Tax Adjustment Amount Per Adjustment in Amount in
Year Category Return SNOD Dispute
Gross receipts or
$1,080,961 $110,016 $110,016
sales
Other deductions
24,941 4,002 4,002
(not listed)
2016 Misc. expenses
116,215 29,341 29,341
(year-end accruals)
Advertising 2,989 1,685 1,685
Net operating loss
171,332 171,332 171,332
deduction
She then turned to the Garibyans, and examined both Armond’s
2015 return, and Armond and Ani’s 2016 return. Armond was
uncooperative with her records request, so she issued a summons to
Comerica for his and Ani’s bank records. She performed another bank-
deposits analysis on their three accounts at that bank. Following
discussions with the Garibyans and their counsel about why certain
deposits in these accounts should be treated as loans or otherwise
nontaxable, she found understatements of income for both 2015 and
2016.
The Garibyans and Lakeview timely petitioned for our review.
We tried these cases in Los Angeles. Because these are California
taxpayers and we don’t have a stipulation to the contrary, appellate
venue presumptively lies in the Ninth Circuit. See § 7482(b)(1)(A),
(B)(b)(2).
The parties settled a lot of issues. What’s left to be decided is
whether:
• Lakeview underreported its gross income or receipts for
2015 and 2016 by $72,829 and $110,016, respectively;
• Armond is required to include an additional $9,621 in his
taxable income for 2015 and another $21,065 in his taxable
income for 2016.
• Lakeview can deduct $4,002 in “other deductions” for 2016;
12
[*12] • Lakeview can deduct $222,218 and $29,341 for
miscellaneous accruals for 2015 and 2016, respectively;
• Lakeview can deduct advertising expenses of $7,233 and
$1,685 for 2015 and 2016, respectively;
• Lakeview had a net operating loss in 2016 of $171,332; and
• Lakeview is liable for accuracy-related penalties.
We will separate this discussion into three parts:
• income,
• deductions, and
• penalties.
OPINION
I. Income
There are two issues of income still outstanding after the parties’
partial settlement. The big issue is Lakeview’s income for 2015 and
2016. The much smaller issue is Armond’s income for 2015 and 2016.
A. Lakeview’s Income for 2015 and 2016
Lakeview reported a $272,124 loss in 2015 arising from
$1,559,083 in total income against $1,831,207 in deductions. It reported
a $171,332 profit in 2016 arising from $1,080,961 in total income and
$909,629 in deductions.
The general rule is that a taxpayer gets to follow its own method
of accounting. See § 446(a). But that’s true only if its method of
accounting clearly reflects income and is consistently followed. § 446(b).
The Commissioner has a degree of discretion in determining whether a
particular method of accounting clearly reflects income. RLC Indus. Co.
& Subs. v. Commissioner, 98 T.C. 457, 491 (1992), aff’d, 58 F.3d 413 (9th
Cir. 1995). But once he’s made up his mind that a taxpayer’s method
doesn’t clearly reflect income, he may determine the existence and
amount of income with a method that clearly and reasonably reflects it
13
[*13] considering all surrounding facts and circumstances. Id.; Treas.
Reg. § 1.446-1(a)(2). 10
Whether Lakeview’s accounting practices square with accrual
accounting under the Code is central to these cases. The Code permits
taxpayers to use the accrual method of accounting to report income. See
§§ 446(a), (c), 451(a). When they elect the accrual method—as Lakeview
did—the regulations say that they must report income in the year in
which all events have occurred which fix the right to receive the income
in amounts that can be reasonably determined. Treas. Reg. § 1.451-1(a).
Income subject to this “all events test” for accrual accounting gets
recognized at the earliest of the date a payment is received, is due, or
the date of the contractual performance. Harkins v. Commissioner, 81
T.C.M. (CCH) 1547, 1550 (2001) (citing Schlude v. Commissioner, 372
U.S. 128 (1963)).
The Commissioner argues that Lakeview’s accounting was such a
mess that we should use his bank-deposits analysis instead. He also
asserts that his RA examined Lakeview’s WF statements against its
ledger and returns. She performed a cash-to-accrual conversion in
conformity with the IRM and removed interaccount transfers and other
clearly identifiable nontaxable deposits. She concluded that Lakeview
underreported its income.
We typically presume the Commissioner’s notices of deficiency
are correct and place the burden on a taxpayer to prove otherwise. See
Welch v. Helvering, 290 U.S. 111, 115 (1933). The same is true when the
Commissioner resorts to a bank-deposits analysis—a taxpayer has the
burden to show that analysis is somehow inaccurate. Palmer v. IRS,
116 F.3d 1309, 1312 (9th Cir. 1997).
The Garibyans argue that it is the Commissioner’s bank-deposits
analysis that is flawed. If they can undermine this analysis by showing
that it includes nontaxable deposits, the burden shifts back to the
Commissioner to try to rehabilitate it. See Clayton v. Commissioner, 102
T.C. 632, 645–46 (1994).
10 For cases appealable to the Ninth Circuit, the Commissioner is also required
to show “some evidence” supporting the taxpayer’s involvement in the activity that
produced the missing income during the year at issue. Weimerskirch v. Commissioner,
596 F.2d 358, 361 (9th Cir. 1979), rev’g 67 T.C. 672 (1977). He easily met this burden
here by introducing Lakeview’s bank records, which show deposits from insurers and
other hospice-related providers. See Helvering v. Taylor, 293 U.S. 507, 515 (1935).
14
[*14] The key questions in resolving this dispute are whether:
• the use of a bank-deposits analysis was appropriate here;
• the Commissioner’s analysis was properly done; and
• the Garibyans’ alternatives and adjustments to that
analysis are correct.
1. Was a Bank Deposits Analysis Appropriate?
Section 446 expressly authorizes the Commissioner to reconstruct
a taxpayer’s income if the method the taxpayer employs doesn’t clearly
reflect income. § 446(b). He has great latitude in doing so—especially
when a taxpayer fails to keep adequate books and records—and his
reconstruction need only to be reasonable in light of all surrounding
facts and circumstances. Id.; Petzoldt v. Commissioner, 92 T.C. 661, 687,
693 (1989).
The Commissioner argues here that his use of a bank-deposits
analysis was justified because Lakeview’s books weren’t maintained on
a proper accrual basis. Comparing the Garibyans’ recordkeeping with
our precedent, we have to agree. Lakeview’s corporate books were
wholly inadequate when lined up against the Code’s requirements. The
overuse of journal entries, zeroing out of accounts receivable seemingly
at random, and inconsistencies with the actual deposits received make
any connection between its books and reality tenuous at best.
Because Lakeview failed to keep adequate books that could be
reconciled with its profit-and-loss statements on its returns, we find that
the Commissioner’s use of a bank-deposits analysis was appropriate.
2. Was the Bank Deposits Analysis Properly Done?
The RA first calculated Lakeview’s gross receipts. Then, to avoid
an understatement of income, she took into account the difference in
accounts payable and accounts receivable, as Lakeview itself reported
on its returns. She added the increases in accounts receivable from the
beginning of the year to the end of the year and assumed that all
deposits were taxable unless shown otherwise. She then deducted the
increase in accounts payable during the same period from gross receipts.
She added decreases in accounts payable to the total deposits.
15
[*15] This is all in accord with the Commissioner’s own guidelines on
how to do a bank-deposits analysis for an accrual-method taxpayer and
produced a clearer reflection of Lakeview’s income than Lakeview’s own
garbled accounting.
For 2015, she found gross receipts of about $2.2 million in
Lakeview’s WF #1732 account and about $2.1 million in its WF #1740
account in 2015. For 2016, she found about $1.1 million and about
$771,000 in gross receipts for these accounts. And she found $1,142 in
nontaxable deposits in the WF #1732 account and roughly $2.2 million
in nontaxable transfers between that account and the WF #1740 account
in 2015. She found nontaxable deposits of more than $860,000 in the
WF #1732 account and $786 in the WF #1740 account in 2016. She did
not find any interaccount transfers.
We summarize the bank-deposits analysis for 2015:
Final
Adjustment
Reported Adjustment Adjustment Addition
Total to Non-
Gross to Accounts to Accounts to Total
Deposits taxable
Receipts Receivable Payable Under-
Deposits
statement
$4,248,083 ($1,896,130) ($2,215,842) ($116,460) $112,702 $132,353
And we do the same for 2016:
Final
Adjustment
Reported Adjustment Adjustment Addition
Total to Non-
Gross to Accounts to Accounts to Total
Deposits taxable
Receipts Receivable Payable Under-
Deposits
statement
$1,957,395 ($1,080,961) ($865,053) ($19,372) $118,007 $110,016
3. Are Lakeview’s Alternatives and Adjustments
Reasonable?
Lakeview disagrees with the RA’s conclusions for several reasons.
The first is that the analysis used the incorrect accounts-payable
figures. We disagree. Lakeview’s reliance on the cash payments
received and bills sent out by Consolo, while a useful source of evidence,
16
[*16] does not undermine the Commissioner’s finding that Lakeview
had unaccounted-for income in its accounts.
Lakeview next argues that the RA failed to consider a net
decrease in cash in the WF accounts at the beginning of Lakeview’s 2014
fiscal year compared to the close of its 2015 fiscal year. Lakeview says
the effect of this was to inflate its gross receipts for 2015, and that it led
to an incorrect balance in 2016. It also claims that the RA missed some
nontaxable deposits.
The Commissioner’s RA, as we’ve mentioned, did use the IRM’s
accrual-conversion process to perform her bank-deposits analysis. She
noted the 2014 balances in the analysis. But this doesn’t mean that the
analysis was improper because of the amounts of these balances.
Lakeview’s final position is that the RA missed some deposits that
it says were nontaxable. It points specifically to deposits from Armond,
Arsen, and Jaurugui. But there are also deposits from phone companies
and even the City of Burbank. The parties stipulated that these
disputed amounts were $89,543.85 for 2015 and $6,058.90 for 2016. But
they also got into a bit of a fight about whether Lakeview had sufficient
proof that some of these deposits were loans or capital contributions.
We think this fight doesn’t make a lot of sense in these cases.
Lakeview was in the hospice business. When it got small deposits from
utility companies or larger deposits from the Garibyans or their friends
or partners, we find it much more likely than not that the source of the
deposits was not paying for hospice services. We don’t really need to
care whether those deposits represent loans or capital or small refunds.
What matters is that they were not part of Lakeview’s taxable income.
We therefore do find Lakeview’s additional adjustments
reasonable, and the parties should take them into account in their
computations.
B. Armond’s Additional Income
We must also decide whether Armond had additional reportable
income for 2015 and 2016. The Commissioner found $89,621 that
Armond purportedly received but failed to report for 2015. The parties
dispute $9,621 of this total. For 2016, the Commissioner found $21,065
that Armond and Ani did not report as taxable income and the parties
dispute the entire total.
17
[*17] Armond points to an unusual pattern of withdrawals and
redeposits. The record shows redeposits shortly after the withdrawals—
for instance, a withdrawal on August 4 from one of Armond’s Comerica
accounts was redeposited in the same amount on the same date in
another Comerica account.
On this one, we agree with Armond. We find it more likely than
not that these were simply transfers from one account to another, not
taxable income. We find that Armond is not required to include this last
$9,621 in his 2015 income.
That leaves the $21,064.62 in extra taxable income still in dispute
for 2016. The Garibyans conceded that Armond had an additional
$46,590 in income from Lakeview that year that was deposited in the
accounts that the RA analyzed. We agree with them that this means
that amount shouldn’t be added again to the total added to their taxable
income by the bank-deposits analysis—that would be double counting.
As best we can tell the RA did subtract this amount from income in her
analysis, but only $32,400 of it. The difference between $46,590 and
$32,400 is $14,190.
We need to subtract that sum from the $21,064.62 that was still
in dispute, which leaves only $6,874.62. And this number, like the
similar number for 2015, roughly matches the cash withdrawals and
redeposits that the Garibyans seemed to have been in the habit of
making.
We therefore find it more likely than not that the sums left in
dispute “as additional income” showed by the RA’s bank-deposits
analysis for Armond’s tax years 2015 and 2016 were not additional
taxable income. The Garibyans win this one.
II. Lakeview’s Business Expenses
Lakeview next argues that, even if it had unreported income, it
also had unjustifiably disallowed expenses. Those disallowed expenses
are:
18
[*18]
Tax Year Deduction (or Loss) Amount
Miscellaneous accruals $222,218
2015
Advertising 7,233
Miscellaneous accruals 29,341
Other deductions 4,002
2016
Advertising 1,685
Net operating loss 171,332
The Code allows a deduction for all ordinary and necessary
business expenses paid or incurred in carrying on a trade or business.
§ 162(a). Taxpayers are required to keep adequate records to
substantiate these deductions. Hradesky v. Commissioner, 65 T.C. 87,
89–90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976).
We begin our discussion with Lakeview’s more than $200,000 in
“miscellaneous accruals” for 2015 and 2016. These may arise from
Lakeview’s agreements with nursing homes for reimbursement of room-
and-board expenses, but Lakeview didn’t substantiate them with
invoices, receipts, or the like—just a copy of a lease. This extreme lack
of substantiation makes it more likely than not the Commissioner’s
disallowance of these expenses is justified.
The disputed advertising expenses at issue for both years appear
to have been paid to Arsen or one of his entities. All we have in the
record to substantiate these expenses are handwritten expense reports
without receipts or invoices. Given the parties’ recordkeeping practices
and potential intermingling of expenses among the Garibyan’s various
other entities, we sustain the Commissioner’s disallowance of these
deductions. For 2016, we also find that Lakeview waived its right to
contest the $4,002 in “other deductions” because it did not address them
in its opening brief. See Stringer v. Commissioner, 84 T.C. 693, 704
(1985), aff’d, 789 F.2d 917 (4th Cir. 1986) (unpublished table decision).
That leaves the disallowed net operating loss. For a net operating
loss to be deductible, a taxpayer must maintain books and records from
the loss years; a return only sets forth its claim and does not by itself
substantiate a prior year’s loss that it can carry forward. See Lee v.
Commissioner, 91 T.C.M. (CCH) 999, 1001 (2006); WB Acquisition, Inc.
v. Commissioner, 101 T.C.M. (CCH) 1157, 1169 (2011), aff’d sub nom.
DJB Holding Corp. v. Commissioner, 803 F.3d 1014 (9th Cir. 2015).
19
[*19] Because Lakeview points to and provides only its previous returns
and its unreliable corporate ledger, we sustain the Commissioner’s
disallowance of this loss.
III. Penalties
The only penalties remaining before us are Lakeview’s accuracy-
related penalties for 2015 and 2016. There’s a 20% accuracy-related
penalty for underpayments attributable to negligence, or a substantial
understatement of the tax due. § 6662(a) and (b)(1) and (2). Negligence
is defined as a lack of due care or failure to do what a reasonable person
would under the circumstances, Treas. Reg. § 1.6662-3(b)(1), and a
substantial understatement in this case is 10% of what Lakeview was
required to show on its returns, see § 6662(d)(1)(B).
Lakeview says it had reasonable cause for the underpayments
and acted in good faith. It has the burden of proof to show this. See
§ 6664(c). Reasonable cause includes an honest misunderstanding of
fact or law that is reasonable given the experience, knowledge and
education of the taxpayer. Treas. Reg. § 1.6664-4(b)(1). When an
accounting system goes awry, there can still be a defense based on
reasonableness and good faith even without the communication of
professional advice needed under a Neonatology defense. See Pankratz
v. Commissioner, T.C. Memo. 2021-26, at *38–39 (finding credible
evidence that taxpayer attempted to correct a previous bookkeeping
problem caused by reliance on a professional). Reasonable cause
requires that a taxpayer exercise ordinary business care and prudence
as to the disputed items. See United States v. Boyle, 469 U.S. 241, 246
(1985).
The Garibyans’ bookkeeping system for Lakeview left much to be
desired during the years at issue. The Garibyans work in an industry
where competent recordkeeping is especially important to getting paid
and avoiding administrative audits. See Patacsil v. Commissioner, T.C.
Memo. 2023-8, at *16 (contrasting the taxpayers with those required to
keep fewer records or with greater organizational skills).
But we also find that the Garibyans aren’t college educated and
relied on two accounting professionals during the years at issue to keep
their books and prepare their returns. One of them, Channels, advised
them to keep their books on an accrual basis, and we find it was the
source of the bizarre entries in Lakeview’s general ledger that rendered
that ledger unreliable.
20
[*20] The nature of passthrough billing for hospice agencies that have
to pass on funds to nursing homes complicated Lakeview’s books.
Neither Lakeview nor the Garibyans had previously had returns
audited by the Commissioner nor been dinged by Medicare or Medi-Cal.
This isn’t exactly similar to Pankratz, T.C. Memo. 2021-26, at *38–39,
where a taxpayer discovered a bookkeeping issue and worked in good
faith to cure it by retaining a different accounting professional. It’s a
closer question, but we find by a preponderance of the evidence that
Lakeview itself had reasonable cause and acted in good faith in using
the bookkeeping system—and in preparing its 2015 and 2016 returns.
CONCLUSION
This is a mixed result. And when combined with the numerous
concessions and stipulations by the parties it means that
Decisions will be entered under Rule 155.