Methods of Proof of Tax Fraud

When the IRS decides to pursue a criminal tax investigation into a taxpayer, it is typically because they believe said taxpayer has committed some sort of tax fraud. Usually that is underreporting of income, overstating their deductions, or not reporting certain income at all. In order for the IRS to prove their case they use specific methods to analyze the situation. They use either direct or indirect methods of proof.

Direct Methods of Proof

Initially, when trying to determine if tax fraud occurred, the IRS may rely on direct proof or specific items to prove their case rather than looking at the taxpayer’s entire financial picture. Here, they pick apart specific transactions to see if the taxpayer earned more money than they reported on their tax returns (mostly). They could also be out to prove that the taxpayer claimed deductions, expenses or credits that they shouldn’t have. The IRS will typically interrogate those closest to the taxpayer or anyone who might have direct knowledge about the issue at hand such as their spouse, their accountant (remember, whatever you share with your accountant is NOT privileged), their employees, etc.

Steps to Develop a Tax Fraud Case

Basically, there are four main steps or guidelines that the IRS follows in order to prove tax fraud:

1. The IRS must prove the relevant amounts are taxable income to the taxpayer
2. They must prove the income was received by the taxpayer
3. They must prove the income was not reported
4. They must prove the taxpayer was personally involved in the failure to report the income

Indirect Methods of Proof

After looking at the direct methods of proof, the IRS may decide they want to expand the scope of their investigation. This is when they would start looking at indirect methods of proof. With indirect methods of proof, the IRS basically looks at the big picture. In other words, they build up a picture of the taxpayer’s finances as a whole rather than looking at them individually and charging them for a specific act. Interestingly enough, this is how Al Capone was ultimately caught. They main objective with these cases is to look for an overwhelming series of practices. As you can imagine, this involves a number of steps or methods.

The first thing the IRS looks at in these cases is the taxpayer’s net worth. And by “looking at” I don’t mean their net worth at one given time. They develop a portrait of it like a detective does with a crime scene. They look at everything. They look at all of the taxpayer’s assets at the beginning of a given year and then also at the end of that year. They try and see if the taxpayer’s net worth improved throughout that year but that the taxpayer did not indicate that on their tax returns. If that is the case, the IRS may win their case on tax fraud or tax evasion.

The next method they use is called the “bank deposit method.” With this method, they go over the taxpayer’s bank account with a fine-toothed comb to try and get an idea of all the monies that flows in and out, where it comes from, etc. For instance, if they see that the taxpayer deposited $200,000 over the course of a year but that taxpayer only claimed $75,000 in income, they’re going to have some questions to say the least. And they will try to build a case against the taxpayer.

Finally, the IRS employs the expenditures method. Here is where they look at a taxpayer’s spending habits. With this method, they are looking for taxpayers who take in large amounts of money but then spend it to live on without declaring it as income. They’re looking for expenditures in terms of regular things like gas, food, etc. Nothing extravagant like cars or expensive jewelry. So let’s say a taxpayer makes $40,000 on a lucrative business deal, takes the payment in cash but then turns around uses it over the course of the next six months to pay for everyday items without every declaring that 40K as income. The IRS will be combing through the previous six months, the spending patterns, credit card bills, bank deposits and withdrawals and comparing it to the other six months where the 40K was utilized which may indicate fraud.

The IRS Is Smarter Than You

The bottom line here is that no matter how smart you think you are – and that may very well be the case – when it comes to tax fraud, the IRS is smarter than you. And they always will be. They have countless tools at their disposal, go through tons of training, they know what to look for, have seen everything, and have very sophisticated investigation methods. You can’t outsmart them and you’d be foolish to even try. It is only a matter of time before they catch you and it is not worth going to prison for (not to mention the hefty penalty and legal fees you’ll have to pay). Nothing is worth your freedom.

Contact an Attorney

If you have made a mistake (we’ve all made our share of them) and need someone on your side, contact Ayar Law today! We offer free, confidential legal advice. Or if you just need someone to talk to about your tax issue. You have nothing to lose by picking up the phone today and calling (800) 571-7175.