Tax Court Risan: Cost of Goods Sold, Alter Ego and Bank Deposits—Lessons for US CPA Firms
Cost of goods sold, the alter ego doctrine and the bank deposits method collided in Risan v. Commissioner, T.C. Memo. 2026-78 (filed September 2, 2026; Judge Holmes). California music entrepreneur Hank Risan—founder of software corporations Media Rights Technologies, BlueBeat and Encryptos, and owner of a collection of roughly 700 to 1,000 vintage guitars—faced multi-million-dollar deficiencies for 2014–2017. The Tax Court rejected the IRS theory that treated corporate bank deposits as his personal income, and it rejected a flawed bank-deposits reconstruction that improperly attributed corporate deposits to him. It still disallowed millions in guitar cost of goods sold, Schedule C expenses, home-office claims and net operating loss (NOL) carryovers for lack of records. Here is what the opinion means for US CPA firms advising owner-operators with inventory and closely held corporations.
What the Tax Court decided in Risan
CPA Practice Advisor (Ken Berry, October 2, 2026) and Business Valuation Resources (October 14, 2026) summarize the posture. The IRS audited Risan’s individual returns for 2014–2017 and related corporate returns for 2016–2017. Risan withdrew corporate funds for personal credit cards and living expenses. He claimed that guitar-business records had been stolen and that a $150,000 ransom demand left him without cost documentation. The Commissioner assessed multi-million-dollar deficiencies and pushed an alter-ego theory plus bank-deposits reconstructions.
On alter ego, California law requires both (1) such a unity of interest and ownership that the separateness of the person and the corporation has ceased, and (2) that adhering to separate existence would sanction fraud or promote injustice. Control and commingling alone are not enough. The Court held the Commissioner failed that showing—including failing to prove who owned BlueBeat and Encryptos—so corporate deposits into those accounts could not be treated as Risan’s personal income. Under Moline Properties, Inc. v. Commissioner, incorporation creates a distinct taxpayer unless the corporation is a sham or the state-law alter-ego test is met.
On bank deposits, the Court tossed the 2014 and 2015 individual reconstructions as fatally flawed (significant omissions and computational errors), and for 2016 and 2017 it excluded BlueBeat and Encryptos deposits after the alter-ego failure. After those corrections, no unreported individual Schedule C gross receipts were sustained for those years. The Court did sustain unexplained deposits on a corporate return where the taxpayer’s proof failed. Separately, it upheld disallowances of guitar cost of goods sold, Schedule C expenses, home-office deductions and NOL carryovers because Risan’s memory and “appraisal experience” were not enough under IRC §6001.
Cost of goods sold is not a §162 expense guess
Cost of goods sold is how inventory sellers compute gross profit. In broad outline, COGS equals beginning inventory plus purchases (and other inventoriable costs) minus ending inventory. That amount is subtracted from sales to reach gross profit before ordinary and necessary business expenses under §162. Inventory costing and capitalization rules live in the regulations under §263A and Treas. Reg. §1.471-3; Publications 334 and 535 walk through the same distinction for Schedule C businesses.
COGS still needs books. Section 6001 and Treas. Reg. §1.6001-1(a) require permanent records sufficient to establish income and deductions. In Risan, the Court declined to estimate guitar purchase and repair costs under Cohan v. Commissioner because there were no specific details to support an estimate. A colorful lost-records story does not replace invoices, inventory logs, purchase journals or ending-inventory counts. Tell clients who sell goods: rebuild from bank statements, supplier invoices and shipping records where you can—and expect the Service to disallow unsupported COGS the same way it disallows unsupported expenses.
Why the corporation usually stays a separate taxpayer
Owner draws from a corporate account are not automatic Schedule C income. Depending on the facts, they may be salary (with payroll tax and withholding), loans, distributions or dividends. Mixing personal and corporate cash raises audit risk and can feed an alter-ego argument, but Risan shows the IRS still must prove the state-law test. Keep separate accounts, document loans with notes and interest, and run payroll when the owner works in the business. Related reading on entity and compensation discipline: our guides to S corporation reasonable compensation and partnership basis and at-risk rules.
Home office, NOLs and substantiation after Risan
The Court also disallowed home-office utility and similar claims where business and personal use were commingled and allocation could not be shown under §280A. That lesson tracks our earlier checklist on the home office deduction under §280A and Form 8829. NOL carryovers failed where the required concise statement and computation under Treas. Reg. §1.172-1(c) were missing. Substantiation failures of this kind are the same family of problems as contribution documentation cases—see charitable contribution substantiation after Williams.
Checklist for US CPA firms
- Map every account in a bank-deposits exam: personal, corporate and related-party. Challenge reconstructions that fold corporate deposits into the owner without a proven alter-ego or assignment-of-income theory.
- Rebuild COGS from documents, not recollection: purchase invoices, inventory counts, job or unit logs, and ending inventory worksheets.
- Separate personal and business banking; document owner draws as payroll, loans or distributions with contemporaneous paperwork.
- Do not rely on Cohan without a credible factual basis for an estimate.
- Attach NOL support (concise statement and schedule) when claiming carryovers, and keep exclusive-use proof for any home-office claim.
Where Tax Brew fits
Tax Brew supports US CPA firms with US tax return preparation support and bookkeeping, including prior-year cleanup when inventory and multi-entity books need reconstruction. Your firm keeps the advice, the representation and the signature. The first 20 hours are free for qualifying engagements. See our services, or email info@taxbrewglobal.com.
Frequently asked questions
What is cost of goods sold versus a business expense?
Cost of goods sold (COGS) is the inventoriable cost of goods a taxpayer sells during the year. In outline, COGS equals beginning inventory plus purchases (and other inventoriable costs) minus ending inventory, and it is subtracted from sales to compute gross profit before ordinary and necessary expenses under IRC §162. Inventory rules appear in Treas. Reg. §1.471-3 and related §263A capitalization rules; IRS Publications 334 and 535 explain the same split for many Schedule C businesses. COGS still requires records under §6001—invoices, inventory logs and ending counts—not unsupported recollection.
When can the IRS treat a corporation as the owner’s alter ego?
Under Moline Properties, Inc. v. Commissioner, a corporation is generally a separate taxpayer. Whether the IRS can disregard that separateness for income attribution often turns on state alter-ego (veil-piercing) law. In Risan v. Commissioner, T.C. Memo. 2026-78, California law required both unity of interest and ownership such that separateness had ceased, and a showing that keeping the corporation separate would sanction fraud or promote injustice. The Tax Court held control and commingling alone were not enough, and that ownership is a prerequisite—so BlueBeat and Encryptos deposits were not treated as the shareholder’s personal income.
What is the bank deposits method, and when does Tax Court reject it?
The bank deposits method treats unexplained deposits as prima facie evidence of taxable income; the taxpayer must show nontaxable sources. In Risan, Judge Holmes explained that an entire analysis can be discarded when it has so many obvious errors that it is arbitrary or without rational foundation (citing Westby and Helvering v. Taylor), after which the burden can shift back to the Commissioner to rehabilitate it. The Court tossed Risan’s 2014–2015 individual reconstructions for major omissions and computational errors, and it excluded corporate deposits from later years after the alter-ego theory failed.
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