When “Too Much Income” Raises Red Flags: Ataya v. Commissioner and the Risk of Inflated Revenue

The central legal issue in Ataya v. Commissioner, T.C. Memo. 2025-55, was not simply whether a taxpayer failed to report income or overclaimed deductions but whether reliance on a preparer or bookkeepers could shield from an accuracy related penalty, especially when the return presented an unusual profile: gross receipts reported above what was supportable.

In Ataya, the overstatement of Schedule C income was not a benign error. It became a catalyst through which inflated deductions were shielded, substantiation collapsed, and the Court found an underpayment after adjustments. The decision provides a sharp lesson: overstating revenue does not protect you from scrutiny. Indeed, it may amplify it.

Factual and Procedural Background

In Ataya, Hani and Inaam Ataya filed a joint return for 2019 and claimed business income and deductions on Schedule C. The IRS, through a Notice of Deficiency, asserted the following:

• Omitted qualified dividends (approximately $9,000)

• Overstated Schedule C gross receipts (in excess of $45,000 above what records supported)

• Deductions (automobile, meals, travel, utilities, and similar categories) that lacked credible backing

• A 20 percent accuracy related penalty under I.R.C. § 6662(a) for negligence or disregard of rules

The Tax Court sustained the adjustments and penalties. The full memorandum opinion is available.

How the Court Adjusted the Return

1. Gross receipts reduced to the supportable amount
   The Court disregarded the inflated receipts and replaced them with amounts consistent with dependable evidence such as bank records, deposits, and cash flow.

2. Heavy disallowance or trimming of deduction claims
   Many of the claimed deductions failed basic substantiation. The Court struck many or reduced them substantially.

3. Net result: corrected income exceeded reported income
   Because deductions were knocked down more aggressively relative to the downward adjustment of gross receipts, the taxpayer’s corrected taxable income exceeded what had been reported.

4. Combined with omitted dividend income, this yielded an underpayment
   The omitted dividend income added further to the deficiency. The excess deductions tied to the inflated revenue could not survive.

Because the corrected return showed a deficiency, the § 6662(a) penalty could properly attach, based on negligence or disregard as found by the Court.

Taxpayer Arguments

-We relied on a competent paid preparer and bookkeepers (one deceased)

-Some records were lost (especially after the bookkeeper’s death)

-We believed in good faith in our professional team’s competence

-We assumed the preparer would detect and resolve errors

-Our circumstances were unusual and burdensome

VS Court Responses

-Reliance is not enough. Under Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43 (2000), one must show that they provided complete and accurate information to the tax professional. The Atayas did not sufficiently demonstrate what documentation or explanations were offered.

-The Court acknowledged the alleged loss but held that the taxpayer remains responsible for substantiation and that loss or unavailability is not a blanket excuse.

-Good faith alone is insufficient. The Court highlighted that the taxpayers lacked any independent review or oversight and failed to spot glaring inconsistencies.

-The Court reaffirmed the principle that the duty to file an accurate tax return is non-delegable. A taxpayer cannot passively rely entirely on others.

-The Court was not persuaded that the circumstances justified relief. The taxpayers did not reconstruct alternative evidence nor provide credible approximations supporting their claims.

Because those defenses failed, the Court upheld the income adjustments, denial of deductions, and imposition of the § 6662 penalty.

Why Overstating Revenue Turned Against Them

It may seem counterintuitive that overstating revenue would increase tax risk. However, in Ataya, the overstatement became pivotal:

• It created the illusion of a larger business base. With artificially high gross receipts, the taxpayer could attempt to justify aggressive deductions (car, travel, meals) that otherwise would have appeared unreasonable.

• When gross receipts were reduced by the Court, the deductions bore no rational relationship to the true revenue.

• The asymmetry of adjustments mattered. The Court trimmed deductions aggressively but was more conservative in lowering revenue. The result was higher corrected taxable income.

• It heightened scrutiny. The overstatement invited closer examination, and once the deductions were reviewed, their lack of foundation became clear.

Thus the overstatement was not an innocent error. It functioned as a leverage tool that collapsed under audit.

Authority and Citations

1. Tax Court Decision – Ataya v. Commissioner, T.C. Memo. 2025-55

2. Internal Revenue Code – IRC § 6662 (Accuracy Related Penalty)
   Available at 26 U.S. Code § 6662.

3. Treasury Regulations – Negligence or Disregard
   26 C.F.R. § 1.6662-3.

4. Treasury Regulations – Reasonable Cause and Good Faith Exception
   26 C.F.R. § 1.6664-4.

5. Additional Context on Substantial Understatement Rules
   26 C.F.R. § 1.6662-4.

Lessons for Business Operators and Executives

• Do not assume high revenue protects you. Inflating gross receipts may supply cover for large expense claims, but once adjustments occur, the mismatch between deductions and true revenue will be exposed.

• Substantiate everything. Receipts, invoices, logs, and support documents must be credible and contemporaneous.

• Document what you hand to the preparer. Keep a record of the documents, explanations, and assumptions you provide to your preparer or bookkeepers.

• Always review your return with business judgment. If deductions appear out of proportion to sales, raise questions and demand explanation.

• If records are lost, reconstruct support with alternative evidence. Do not rely on the absence of records as a defense.

• Treat your tax return as more than compliance. An audit resilient return is one you can explain, support, and defend.

Final Thought

Cases like Ataya v. Commissioner serve as a reminder that both understatement and overstatement of income can expose taxpayers to penalties. If you are a business owner or executive facing complex reporting issues, I can help you navigate the tax rules and strengthen the defensibility of your return. Schedule a consultation with me today to ensure your tax filings are accurate and audit ready.