Canatella v. Commissioner of Internal Revenue, 062617 FEDTAX, 19375-13

Docket Nº:19375-13
Opinion Judge:MORRISON, JUDGE.
Attorney:Richard A. Canatella, for himself. L. Katrine Shelton, Brenn C. Bouwhuis, and Charles B. Burnett, for respondent.
Case Date:June 26, 2017
Court:United States Tax Court

T.C. Memo. 2017-124




No. 19375-13

United States Tax Court

June 26, 2017

Richard A. Canatella, for himself.

L. Katrine Shelton, Brenn C. Bouwhuis, and Charles B. Burnett, for respondent.



The respondent (referred to here as the "IRS") issued a notice of deficiency to the petitioner, Richard A. Canatella, for the taxable years 2008, 2009, and 2010. The IRS determined tax deficiencies of $248, 262 for 2008, $92, 758 for 2009, and $128, 167 for 2010, and accuracy-related penalties under section 6662(a) of $49, 652 for 2008, $18, 552 for 2009, and $25, 633 for 2010.1 Canatella timely filed a petition under section 6213(a) for redetermination of the deficiencies.2 We have jurisdiction under section 6214. In this opinion we hold: 1. The Court did not err in allowing the revenue agent to remain in the courtroom after Canatella's request to exclude fact witnesses from the courtroom at the beginning of trial. See infra part 1.

2. The counsel for the IRS did not engage in misconduct due to the mislabeling of exhibits. See infra part 2.

3. The IRS's bank-deposits analysis is not erroneous as a whole. However, $124, 000 in deposits were improperly characterized as income to Canatella for 2008. See infra part 3.


Some of the facts have been stipulated and are so found.

I. Background

In 2008-10, Canatella operated a law firm doing business as Cotter & Del Carlo. He was the only lawyer in the firm, which operated as a sole proprietorship. Before its winding up of business in 2010, the firm had been in existence over 40 years and specialized in probate matters.

As a result of litigation or settlements, Canatella often received funds payable to his clients and was obligated to hold the funds in trust until distributions were warranted. From 2008 to 2010, Canatella maintained 20 bank accounts at six financial institutions.


Tax Reporting; Notice of Deficiency

Canatella filed late Forms 1040, "U.S. Individual Income Tax Return", for 2008, 2009, and 2010. Canatella filed both his 2008 and 2009 returns on June 10, 2011, and his 2010 return on November 4, 2011.

During each of the three years, Canatella filed under the status of married-filing-separately. An accountant prepared each of the returns. On his returns for 2008, 2009, and 2010, Canatella did not report any income other than the business income that he reported on his Schedules C, "Profit or Loss From Business". The Schedules C reported the following business income, expenses (broken down into various categories), and gain/loss from the operation of Cotter & Del Carlo:

2008 2009 2010
Gross receipts $509, 486.00 $382, 372.00 $170, 654.00
Expenses 436096 311130 210851
Net profit/loss 73390 71242 -40197
Even though Canatella reported only business income on his tax returns, the IRS received information returns from payors showing that they paid Canatella interest and Social Security income. The IRS initiated an audit of the 2008, 2009, and 2010 returns on account of both his failure to timely file these returns and his failure to report on the late-filed returns his interest and Social Security income. The IRS, through its revenue agent, requested documents from Canatella regarding his business income, interest income, and Social Security income. In response, Canatella provided (1) a QuickBooks ledger and (2) canceled checks that had been deposited into his main business checking account, No. 9667. The documents neither referenced the other bank accounts receiving interest income nor accounted for discrepancies in interest and Social Security income. The IRS issued summonses to all the banks where Canatella had accounts open during the three-year period. Using the summoned account information, a bank-deposits analysis reconstructed Canatella's income. In conducting the bank-deposits analysis, the IRS: (1) totaled all deposits into all Canatella's bank accounts, (2) subtracted out all deposits (or portions of deposits) determined to be nontaxable, including interaccount transfers and refunds, and deposits from nontaxable sources, (3) subtracted the amounts of income that Canatella had reported on his tax returns, and (4) determined that the resulting amount for each year was Canatella's unreported Schedule C gross receipts. In its bank-deposits analysis the IRS did not determine that any deposits into account No. 9193 were taxable because it determined that account No. 9193 was an IOLTA account. An IOLTA account is an account for client funds that are in small amounts or held for short periods. The IRS provided Canatella with a copy of the bank-deposits analysis and gave him an opportunity to contest it. Canatella did not furnish any additional documents to contest the bank-deposits analysis. The IRS mailed a notice of deficiency to Canatella for 2008, 2009, and 2010 on May 31, 2013. Reflecting the bank-deposits analysis, the notice determined Canatella under-reported his Schedule C income by $285, 725 for 2008, ($36, 391) for 2009, 3 and $232, 827 for 2010. The notice disallowed certain business-expense deductions Canatella claimed on his...

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