Algarawi v. Commissioner

Tax Pro With 3,000 Clients Audited Over 'Donation Box' Income

A tax preparer who filed over 3,000 returns for others now faces a tax bill of roughly $43,000, plus penalties, after the Tax Court determined he failed to report income collected through a "donation box" and Zelle payments. In Algarawi v. Commissioner, T.C. Memo. 2026-8, Judge Pugh ruled against Jabir Algarawi and Amira Hachim for the 2020 and 2021 tax years. The IRS assessed deficiencies based on a bank deposits analysis, arguing that the funds represented unreported business income. Algarawi claimed the deposits were charitable contributions he collected and passed on to needy families. However, because Algarawi maintained no records to substantiate his claim, the court sided with the IRS, treating the ~$43,000 as taxable income and subjecting him to accuracy-related penalties under Section 6662(a).

The Facebook Fundraisers and the Zelle Accounts

The case centered on Jabir Algarawi, who served as president of the Arizona Allnation Refugee Resource Center (Allnation) while also operating a tax preparation business, Ali Tax Income, as a sole proprietorship. The sheer volume of Mr. Algarawi's tax practice was notable: he prepared 1,294 returns in 2020 and 1,953 in 2021. Yet, on Schedules C, Profit or Loss From Business, attached to his 2020 and 2021 returns, he reported only $12,548 and $12,458, respectively, in gross receipts from Ali Tax Income.

Adding another layer, Mr. Algarawi encouraged his tax clients to donate to Allnation through a "donation box" situated outside his office. Crucially, he kept no records of these cash deposits and did not provide receipts to the donors. These cash donations were deposited into Mr. Algarawi's personal bank account, as Allnation did not maintain its own separate account.

Mr. Algarawi also received funds through a Facebook group focused on assisting the refugee community. Members of the group would post solicitations for donations to help specific families in need, directing donors to Mr. Algarawi, who received the funds via his Zelle account linked to his cell phone. Similar to the donation box proceeds, Mr. Algarawi kept no records of the donors, the amounts of their contributions, or the recipients of the donations and the amounts they received.

The 'Conduit' Defense: Charity or Income?

The IRS, in its deficiency determination, relied on a bank deposits analysis, identifying approximately $165,000 in unreported income. The IRS's position was based on the established principle that bank deposits are prima facie evidence of income. This means that, absent a compelling explanation, the deposits are presumed to be taxable income to the depositor. The IRS argued that Mr. Algarawi's deposits, lacking any contradictory evidence, should be treated as such.

Mr. Algarawi countered that these deposits represented donations he merely passed through to needy families, operating as a conduit. He testified that community members donated funds to him, which he then used to pay the expenses of families in need. In tax law, the "conduit theory" argues that funds received are not income if the taxpayer acts solely as an intermediary, lacking dominion and control over the funds.

In an attempt to substantiate his claim, Mr. Algarawi sought to introduce letters (Exhibits 22-P through 27-P) from community members, dated just days before the trial, to corroborate his testimony. The letters purported to show that Mr. Algarawi provided free tax preparation services, received money from community members, and subsequently distributed those funds to others in need. The IRS objected to the admission of these exhibits on multiple grounds, arguing that they were untimely disclosed, constituted inadmissible hearsay, and lacked relevance.

Judge Pugh: No Records, No Defense

As the previous section described, Mr. Algarawi sought to introduce letters from community members to support his claim that he was merely a conduit for charitable donations. Judge Pugh, however, found these efforts fell far short of establishing a valid defense against the IRS's assessment of additional tax.

The court first addressed the admissibility of the letters (Exhibits 22-P through 27-P), finding their late production prejudiced the IRS, who lacked sufficient time to review and verify them. Citing Enis v. Commissioner, T.C. Memo. 2017-222, the court emphasized the importance of timely disclosure. Moreover, the court deemed the letters inadmissible hearsay under Rule 143(a) and Federal Rule of Evidence 802, as no applicable exception to the hearsay rule (under Federal Rule of Evidence 803) was identified.

Turning to the core issue of unreported income, Judge Pugh explained that Section 61(a) defines gross income as "all income from whatever source derived." This includes "deposits into all accounts over which the taxpayer has dominion and control," as stated in Chambers v. Commissioner, T.C. Memo. 2011-114, referencing the Supreme Court's holding in Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

Mr. Algarawi argued that the deposits were charitable contributions he passed along to others, acting merely as a conduit. However, the court found that aside from the inadmissible letters, "he offers no evidence tying specific deposits to the ultimate recipients." Judge Pugh emphasized that with "no evidence showing which deposits were passed along, we cannot conclude on this record that Mr. Algarawi did not have dominion and control over any particular deposits." Therefore, even accepting his legal theory, the court could not exclude any deposits from his gross income due to a lack of proof. Moreover, the court noted that even if Algarawi had properly documented these purported donations, a charitable contribution deduction would be unavailable under Section 170(c), because funds given directly to an individual for personal benefit are deemed gifts, not deductible charitable contributions.

The court also dismissed the notion that the deposits represented donations collected on behalf of Allnation, Mr. Algarawi's non-profit. Neither Ali Tax Income nor Allnation provided receipts to donors, and Mr. Algarawi deposited the funds into his personal bank accounts. No evidence showed corresponding transfers to Allnation, partly because Allnation lacked a separate bank account. The court concluded that while it did not question the Algarawi's desire to support refugees, the "gaps in petitioners’ proof, especially given Mr. Algarawi’s occupation as a paid tax return preparer, sink their arguments."

Finally, the court addressed amended returns and a claim for a "sick leave and family leave" credit related to COVID-19, raised by the petitioners after trial. Citing Rule 34(b)(1)(G), the court noted that issues not raised in the petition are deemed conceded. Because these issues were not raised in a pretrial memorandum or supported by evidence during trial, and because the IRS would be prejudiced by their late introduction, the court declined to consider them.

Therefore, Judge Pugh sustained the IRS's determinations, finding that the Algarawis had not met their burden of proof.

In addition to the bank deposits, the IRS determined that Mr. Algarawi had $5,615 of cancellation of credit card debt income, despite receiving no Form 1099. The court confirmed that under Section 61(a)(11), income includes the discharge of indebtedness, making this amount taxable.

The Price of Poor Recordkeeping

The court upheld the IRS's determination that the Algarawis were liable for accuracy-related penalties under Section 6662(a), which imposes a 20% penalty on underpayments of tax due to a substantial understatement of income or negligence. To impose this penalty, the IRS must meet an initial burden of production, showing that the penalty is appropriate and complying with Section 6751(b)(1), which requires supervisory approval of the penalty assessment. Once this burden is met, the taxpayer must prove the IRS's determination is incorrect or that they had reasonable cause for the underpayment, as per Section 6664(c).

Here, the IRS demonstrated that the Algarawis' understatement of income was substantial, exceeding the greater of $5,000 or 10% of the tax required to be shown on their return, and that the examining agent's supervisor approved the penalty in writing. The burden then shifted to the Algarawis to demonstrate reasonable cause, which Treasury Regulations Section 1.6664-4(b)(1) defines as acting in good faith based on all facts and circumstances, including the taxpayer's experience and knowledge.

Judge Pugh found that the Algarawis failed to meet this burden. The judge specifically noted Mr. Algarawi's experience as a paid tax return preparer, having prepared over 3,000 returns during the years in question. Given his professional status, the court reasoned that he could not credibly claim ignorance or reasonable cause for failing to keep adequate records of the alleged charitable contributions or for Ali Tax Income.

The Algarawi case serves as a warning to tax practitioners: professional status raises the bar for personal tax compliance. The court's decision underscores that tax professionals are expected to maintain a higher standard of recordkeeping and cannot easily claim "reasonable cause" for errors stemming from a lack of basic documentation.