## Facts

- Charles S. Nicholson and Linda S. Nicholson filed joint federal income tax returns for the years at issue.
- The IRS issued a notice of deficiency asserting the Nicholsons failed to report approximately $387,000 of income.
- The notice stated only that the $387,000 was taxable because the Nicholsons did not establish the amount was excludable under the Internal Revenue Code.
- The notice did not identify any source of the alleged income or explain how the IRS computed the $387,000 figure.
- In the Tax Court proceedings, the Commissioner initially presented the case at trial as an indirect reconstruction based on comparing the Nicholsons’ reported income with their expenditures (a cash-expenditures approach).
- After trial, the Commissioner abandoned the expenditures approach and, in a post-trial brief, asserted that the unreported income came from six specific sources not identified in the notice.
- The Nicholsons argued that the IRS’s post-trial shift raised a new matter under Tax Court Rule 142(a) and, more broadly, that the deficiency determination lacked the factual predicate required for the usual presumption of correctness in unreported-income cases.

## Issues

1. Whether the deficiency notice, which asserted $387,000 of unreported income without stating a factual basis, was entitled to the normal presumption of correctness in an unreported-income case.
2. Whether the Commissioner’s post-trial change from an expenditures theory to a six-sources theory was a new matter under Tax Court Rule 142(a), placing the burden of proof on the Commissioner.
3. Whether, under the proper burden allocation and on the trial record, the Commissioner proved that the Nicholsons received unreported taxable income in the amount determined.

## Decision

- The Tax Court concluded that the IRS’s determination was not entitled to the normal presumption of correctness because the notice provided no factual foundation linking the Nicholsons to the alleged unreported income and the IRS relied on inconsistent theories.
- The court treated the Commissioner’s post-trial six-sources theory as a new theory raised after trial and required the Commissioner to support the asserted unreported income with evidence.
- The Commissioner did not carry the burden to establish that the Nicholsons received the alleged $387,000 of unreported taxable income.
- The court entered judgment for the Nicholsons on the unreported-income deficiency issue.

## Legal Principles

- A notice of deficiency is generally presumed correct, and taxpayers ordinarily bear the burden of proof in the Tax Court.
- In unreported-income cases, the presumption of correctness does not apply unless the Commissioner first provides a minimal evidentiary foundation connecting the taxpayer to an income-producing activity or to receipt of unreported income; a conclusory “naked assessment” is insufficient.
- Under Tax Court Rule 142(a), the Commissioner bears the burden of proof as to a new matter—i.e., a theory or position that raises different operative facts and would require the taxpayer to meet different evidence than the theory fairly presented by the notice and litigated at trial.
- When the Commissioner abandons one reconstruction theory and substitutes a materially different factual explanation after trial, the Commissioner must prove the facts necessary to support the deficiency on the new theory.

## Conclusion

Nicholson holds that the IRS could not rely on the ordinary presumption of correctness where its notice merely alleged $387,000 of unreported income without any factual explanation, and where the IRS then shifted from an expenditures analysis at trial to a six-sources theory in post-trial briefing; with the burden on the IRS to supply a factual foundation and prove the alleged unreported income, the IRS failed to do so and the deficiency could not be sustained.


Nicholson v. Commissioner, 65 T.C.M. 2478, T.C. Memo. 1993-183 (1993)