## Facts

- Ramon and Dolores Portillo filed a 1984 federal income tax return reporting Ramon’s receipts from subcontract painting work using his handwritten ledger and available Forms 1099.
- One contractor, Navarro, had not issued a Form 1099 by the time the return was prepared, so Portillo reported Navarro-related receipts based on his ledger.
- Navarro later filed a Form 1099 reporting payments to Portillo about $24,000 higher than Portillo reported.
- The IRS issued a notice of deficiency for unreported income relying solely on the discrepancy between the return and Navarro’s Form 1099.
- During the IRS inquiry, Navarro could not provide documentary support for the Form 1099 amount, and the IRS did not otherwise substantiate the asserted additional income.
- In Tax Court, the Commissioner prevailed on the ground that the deficiency was presumed correct and Portillo failed to disprove it; the Tax Court also declined to reconstruct Portillo’s business expenses for 18 weeks lacking documentation.
- Portillo appealed to the Fifth Circuit.

## Issues

1. Whether a deficiency based on computerized matching of a third-party Form 1099 to a taxpayer’s return satisfies the “determination” requirement of I.R.C. § 6212(a).
2. Whether a deficiency notice asserting unreported income, based solely on an uncorroborated Form 1099 that the payor could not substantiate, is arbitrary and therefore not entitled to the presumption of correctness.
3. Whether the Tax Court erred by refusing to reconstruct business expense deductions for periods where the taxpayer lacked documentation.

## Decision

- The court held that the IRS’s computerized matching and issuance of a notice of deficiency satisfied the statutory “determination” requirement under I.R.C. § 6212(a).
- The court reversed the Tax Court on the unreported-income deficiency, holding the notice was arbitrary and erroneous because the IRS failed to substantiate that Portillo received the alleged additional income.
- The court held the deficiency did not carry the usual presumption of correctness; the IRS bore the burden to produce evidence supporting the alleged unreported income and failed to do so.
- The court affirmed the Tax Court’s refusal to reconstruct expense deductions for 18 weeks because Portillo did not prove he incurred those expenses.
- The judgment was affirmed in part, reversed in part, and remanded.

## Legal Principles

- A notice of deficiency may be based on information derived from computerized matching and can satisfy I.R.C. § 6212(a) if it links the taxpayer to the asserted deficiency.
- The presumption of correctness does not attach to a “naked” assessment of unreported income that lacks a rational evidentiary foundation.
- When the IRS asserts unreported income based only on an unsubstantiated third-party information return, and does not investigate despite clear reliability concerns, the deficiency may be arbitrary and the IRS must come forward with evidence supporting the income allegation.
- Deductions are a matter of legislative grace, and the taxpayer bears the burden of substantiating entitlement; courts need not reconstruct expenses where the taxpayer cannot credibly prove they were incurred.

## Conclusion

The Fifth Circuit held that while the IRS may issue a deficiency based on information matching, a deficiency asserting unreported income cannot rest solely on an uncorroborated Form 1099 when the IRS does not otherwise substantiate the allegation; in that situation, the presumption of correctness falls away and the IRS must prove the income, but taxpayers still must substantiate claimed deductions.


Portillo v. Comm’r, 932 F.2d 1128 (5th Cir. 1991)