Do you have any documentation of that story?

Heard around the campfire from a usually reliable source. The pilot
was supposedly local (meaning Texas-based). Nothing documented. AFAIK
there wouldn't have been documentation anyway. I doubt an LOI was ever
issued.

I'm curious how an FAA
inspector would have been able to establish that the pilot had taken a tax
deduction.

AFAIK it was simply an assumption - and virtually guaranteed to be
correct, since virtually every pilot does take the deduction.

According to them, the order came
about in response to an erroneous Internet rumor to the effect that the FAA
considers tax deductions to be compensation.

I recall that the story did come out on the internet, minus names (is
there such a thing as non-rumor on the internet?) so my only objection
is their characterization of the rumor as erroneous. Maybe it was, but
I have reason to believe it wasn't.

My guess is that the original situation was communicated to people as
it happened, and wound up on the internet, taking on a life od its own,
even after the issue was settled. I looked at the link you provided,
and it gave a pilot's name supposedly associated with the inquiry -
Texas-based, but part of Angel Flight, not AirLifeLine.

Michael