Chap 11 LectureNetworth

Chap 11 LectureNetworth - UNIT 5 APPENDIX A METHODS USED TO...

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UNIT 5 APPENDIX A - METHODS USED TO SEARCH FOR UNREPORTED INCOME NET WORTH AUDIT METHOD Among the government’s most powerful weapons to prove unreported income is the net worth method of proof. The net worth method is a common indirect balance sheet approach to estimating income. This method of proving unreported income, often used in tax evasion and civil fraud cases, is one of a number of methods that assume that the taxpayer has hidden his income; therefore, true income cannot be proven directly. Since the Supreme Court has long overcome all objections to its legitimacy, the net worth method is easy for agents to use and often traps taxpayers by their own prior statements and admissions. WHEN THE IRS USES THE NET WORTH AUDIT The IRS will typically undertake a net worth investigation when one or more of the following conditions exist: The taxpayer maintains no books and records; The books and records are not available; The books and records are inadequate; or The taxpayer withholds his books and records. To use the net worth technique, an IRS agent must calculate the person’s net worth (the known assets less known liabilities) at the beginning and ending of a period. The agent adds nondeductible living expenses to the increase in net worth. If there is a difference between the reported income and the increase in net worth during the year, the agent tries to account for the difference as (1) nontaxable income and (2) unidentified differences. Any unidentified difference may be an approximation of the amount of a theft, unreported income, or embezzlement amount. The IRS does not have to rely on the taxpayer’s books and records, even if they are adequate and accurate. Sometimes the government views these records as “self serving” and may use any evidence to confirm or contradict the taxpayer’s records. Typically, the IRS will look at all available records, the taxpayer’s inventories, physical assets, financial statements to other creditors or other government agencies, bank records, securities, personal inventories, and any other statements of assets. This technique is used when there is a year-to-year increase in net worth and the taxpayer does not have adequate records to determine taxable income or when fraud is strongly suspected. TYPICAL NET WORTH CASE The net worth method is premised on the following reasoning: When a taxpayer accumulates wealth during a tax year, he invests it (in assets) or spends it. Increases in the taxpayer’s net worth throughout the year presumptively represent taxable income. Nondeductible expenditures are then added to these increases in net worth. However, deductible expenditures are not added to net worth, since tax-deductible expenditures are already taken into account in the net worth formula. See net worth example following.
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GOVERNMENT’S BURDEN OF PROOF In a net worth case, the government must establish a likely source of income and follow up leads. The government may also attempt to show that the increase in net worth is not
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This note was uploaded on 02/29/2012 for the course FORENSIC 101 taught by Professor ? during the Spring '12 term at Post.

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Chap 11 LectureNetworth - UNIT 5 APPENDIX A METHODS USED TO...

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