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IRS methods of gathering evidence to prove tax crime

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IRS methods of gathering evidence to prove tax crime

The strongest evidence of a taxpayer’s willfulness is typically the size of taxpayer’s tax deficiencies that can be proven to occur over a number of years. Experience has shown the Government that a greater amount of tax deficiency can usually be established by including the use of circumstantial evidence than by the use of direct evidence of omitted income alone.

Circumstantial Methods of Proof:

Net Worth Method

Under the net worth method, the taxpayer’s net worth (total assets minus total liabilities) at the end of one year is compared with his or her net worth at the end of the next year. The method calculates net income for a year by measuring the increase in net worth over a particular year which is reduced by any nontaxable sources of income received by the taxpayer such as loan proceeds or inheritances. The agent then compares the taxable income reported for the year being tested with the results of the net worth computation and thereby identifying any unexplained increase in net worth for the year tested as unreported income.

Expenditures Method

The expenditures method for uncovering omitted income is similar to the net worth method and is sometimes referred to as the cost-of-living test. This method focuses on the amount of income needed to cover the taxpayer’s identified personal expenditures for the year being tested. The agent totals all the identified personal expenditures of the taxpayer for the year tested and reduces the total by any nontaxable sources of income used to pay for the expenditures. Since one possible source of nontaxable income for the expenditures tested is wealth acquired and taxed in previous years, the agent must take into consideration all of the taxpayer’s assets and liabilities at the start of the prosecution period, in the same manner as in a net worth case. Commonly the IRS combines the net worth and personal expenditures methods to assure that its computations reflect the income used to purchase assets as well as the income used for personal expenditures.

Bank Deposits Method

Taxpayers who run Schedule C businesses and make periodic deposits to at best, a business bank account, and at worst, a commingled personal account, are typically investigated by the IRS using the bank deposits method. The agent totals deposits to all accounts (bank and brokerage) under the taxpayer’s control and then eliminates any deposits from identified nontaxable sources, such as gifts, loans, and transfers between accounts. The adjusted total of deposits is considered income. The IRS uses these methods to establish an income-producing business which allows the jury to infer how the unreported taxable income was generated. This method is also commonly used for businesses run through entities such as LLCs, S and C Corporations, and Partnerships.

Specific Item Method

Under the specific item method of proof, the government attempts to show that the taxpayer’s return at issue inaccurately reflects a specific transaction, or set of transactions, such that income is omitted, deductions are inflated or a source of income is falsified. The government is not burdened with having to prove an exact amount of unreported income to prevail but rather must prove that a substantial amount of income was unreported.


Extraordinary Criminal Investigation Division Techniques

Where appropriate, CID special agents employ surveillance, issue search warrants, implant undercover agents and utilize scientific experts to aid in a criminal investigation. For example, CID Agents have been known to go so far as to sift through a suspect’s trash to secure evidence. Note: Courts have held that you generally have no expectation of privacy in your trash and thus you were not subjected to an unreasonable search. Good defense attorney’s can sometimes suppress evidence obtained by the IRS using these extraordinary techniques. In one reported case, the IRS obtained a search warrant to search a taxpayer’s real estate office and seized all the documents contained therein. At trial, none of the documents seized were allowed to be introduced because defense counsel successfully argued that the search warrant was overbroad. Defense Counsel can also exploit the detailed restrictions on the use of these extraordinary techniques as contained in the Internal Revenue Manual.

Contact an Irvine Criminal Tax Attorney

Contact me, an Orange County, Irvine, Los Angeles County and Westwood criminal tax audit lawyer, to schedule your reduced rate initial consultation today.