Question

Most Criminal Investigation cases involve proving that the taxpayer received income which was willfully not included on his or her tax return, or in the collection context, proving that the taxpayer willfully failed to pay taxes when possible to do so. The latter also requires that the IRS be able to reconstruct the taxpayer's income stream, often using indirect methods, such as using the taxpayer's bank deposits to determine the amount of income received by reviewing the deposits made to the accounts. This type of indirect income reconstruction is often used in civil fraud cases.

What do you think is fair game for the IRS to consider when reconstructing income?

Bank loan applications, court records from divorce proceedings, financial forms turned in bankruptcy proceedings - what should be reviewed by the IRS?  

What defenses would you use if the IRS were trying to use these sorts of documents to reconstruct your client's income for a past year?

Answer 1

Taxpayer defense can be grouped into three categories :

1.Showing that computation is inaccurate

2.Shwing that unexplained difference is due to non taxable source

3.Showing that unexplained difference is from expenitures of available cash accumulated in prior years

It is nt a fair game of IRS to consider in this way .

While the idea of the Internal Revenue Service reviewing your federal income tax return initially seems like a cause for concern, the actual level of reviewing varies from automated error scanning to manual reviews by personnel. Should the IRS identify an issue, problems are typically easily resolved.

Processing of Electronic Returns

If your small business used tax preparation software or a website to electronically file, or e-file, the return for the tax year in review, the acceptance of the return by the IRS does not mean the return has been error-checked or reviewed. Instead, it means the IRS acknowledges receipt of the return. The return then enters a processing or review stage in which IRS computers scan the return to check for errors and verify the inclusion of all forms and schedules needed. After the computer review is over, the return is either approved, flagged for errors or flagged for a personal review.

Errors on Tax Form

The complexity of small-business taxes and tax forms lends itself to errors when the taxpayer is not familiar with the filing process. However, an error in calculation or an improperly claimed tax credit does not automatically trigger an audit. The IRS corrects calculation and credit claiming errors on returns and adjusts the taxes owed accordingly. If your business paid taxes, a bill for the remaining taxes due is generated. When a refund is due, the amount of the refund adjusts down to cover the new taxes owed. Conversely, an error correction that reduces taxes owed generates a refund for overpayment or increases the amount of the previously calculated refund.

CP05 Notices

The IRS codes the different types of notices sent to income tax filers. The CP05 notice is sent to tax filers with returns officially under review. A CP05 review means the IRS needs to verify data on your income tax return. For some issues, you or your small business may need to provide additional information, but other times, the IRS contacts third parties to double-check the total withholdings, credits and income reported on the return.

Audits

While a review does not equal an automatic audit, it can lead to an audit. As long as your business reported earnings and withholdings to the IRS accurately, or with unintentional errors, an audit should be uneventful. The IRS conducts a portion of audits by mail by requesting additional information related to your return, while others take place face-to-face in your home, business or at an IRS field office. After the auditor reviews your books and determines that the income tax return or returns in question were filed properly and the auditor's manager approves the results, the process ends. If there are errors or inaccuracies in the returns that result in a tax liability, the liability needs to be paid or a payment plan needs to be set up with the IRS. If an additional refund is merited, the IRS will remit payment.