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How the IRS tries to catch taxpayers underreporting income

On Behalf of | Aug 7, 2015 | Audits |

The IRS is aggressive in pursuing taxpayers it believes has underreported its income. The agency estimates that the federal government loses hundreds of billions per year in unpaid taxes due to underreported income, according to CBS News. This explains why IRS agents conduct field audits, also called face-to-face examinations.

The IRS uses several tools to build evidence that a taxpayer is supposedly hiding something. Among them are:

  • T-account analysis. This method is essentially a comparison of the taxpayer’s sources of money and his or her expenses. If the expenses outstrip the cash, the IRS may ask the taxpayer to explain the difference. This does not mean the taxpayer has committed fraud; he or she could have nontaxable income.
  • Bank deposit analysis. In addition, the IRS will likely ask to look at your bank account’s deposits, to see if there were any deposits that were not reported. Again, some legitimate deposits, like life insurance proceeds and gifts, are nontaxable.
  • Internet activity. A business that conducts online transactions may find its Internet activity probed.
  • Information statements. The IRS will take copies of your income reporting statements, like 1099s and W-2s, and uses computer software to compare them to your tax return.
  • Business financial ratios. The IRS assumes that self-employed people and small business owners are trying to make a profit. Agents conducting a field audit may compare financial ratios like gross income and profit ratios to the numbers reported by a similar business, using online resources for their data.

An audit is not the end of the world, and with the help of an attorney, you will get through it.

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