Tax Law and Tax Compliance Fundamentals
This domain tests how the Tax Compliance Officer applies the Internal Revenue Code to examination facts: what is income, what is deductible, who is liable, which records substantiate an item, and how burden of proof and limitations periods shape a case.
Core rules
- IRC §61 defines gross income broadly as all income from whatever source derived unless specifically excluded. Income is taxed to the person who earns it under the claim-of-right doctrine, even if it must later be repaid.
- IRC §162 allows deductions for ordinary and necessary business expenses. IRC §262 bars personal, living, and family expenses. Capital expenditures must be capitalized and recovered through depreciation or amortization.
- IRC §274(d) requires strict substantiation for travel, meals, gifts, and listed property. Adequate records or sufficient corroborating evidence are required; oral testimony alone is generally insufficient.
- IRC §6001 requires taxpayers to keep records sufficient to establish liability. The taxpayer generally bears the burden to prove deductions and credits; the IRS bears the burden on a deficiency except under limited IRC §7491 conditions.
- Information returns such as Form W-2, 1099-NEC, 1099-MISC, and 1099-K are matching tools, not conclusive proof of income or expense.
Worked example
A sole proprietor deposits $82,000 into a business account and reports $60,000 of gross receipts. He says $22,000 was loans from family, but provides no loan documents, no interest terms, and no repayment schedule. In a bank deposits analysis, deposits are evidence of income, not an automatic legal definition of income. The taxpayer must identify a nontaxable source. Because he cannot support the loan claim with statements, ledgers, or repayment evidence, the examiner may include the unexplained deposits in gross receipts. If he produced a signed loan agreement, transfer records, and repayment evidence, those deposits could be excluded.
Traps that cost marks
Treating gross receipts as net profit; deducting personal expenses as business expenses; accepting summary schedules without receipts; forgetting self-employment tax and estimated tax consequences; assuming a 1099 amount is correct without matching; confusing capital and expense items; and misapplying §274(d) substantiation to ordinary supplies.