Unreported Income

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How Does the Internal Revenue Service Find Unreported Income?

Ever wonder how the Internal Revenue Service goes about finding income taxpayers fail to report on their tax returns?  The tax collector can track down what a taxpayer may try to hide by using a combination of high tech and low tech methods.

Electronic transactions.  We leave an electronic trail of our daily lives all over the place.  It is hard to hide, even if you think you are using cash only and living under the radar.

Bank Statements
One way the Internal Revenue Service finds unreported income is to examine bank statements at an audit. Many taxpayers believe Internal Revenue Service will not look at their bank records, but in fact, in unreported income cases, most of the taxes recovered by the Internal Revenue Service during an audit are discovered by an analysis of taxpayers' bank statements.

Third Party Contacts
Another method of identifying unreported income is through third-party contacts. The auditor will contact various parties with whom the taxpayer does business. If the taxpayer is a contractor working for different companies, the Internal Revenue Service will contact those companies and ask to examine the checks the taxpayer should have received. The back of the checks will tell if they were deposited in the taxpayer's account, cashed at a check cashing facility or perhaps a liquor store. If the checks were not deposited into the taxpayer's bank account, the auditor will determine whether the checks were reported on the tax return.

Life Style Review
Still another method which the Internal Revenue Service has tried is the so-called "life style" audit. The Internal Revenue Service tries to match the income the taxpayer reports with his or her lifestyle. A taxpayer who wears a fur coat, diamond rings and has a chauffeur but only reports $35,000 per year as income, may need to explain to the Internal Revenue Service why there is such a disparity between the income reported and the personal lifestyle. Is the taxpayer able to show he or she received loans, gifts or had some other source of nontaxable income?

Market Segment Specialization Program
In the Audit Technique Guides (ATG), the Internal Revenue Service has done in depth studies of various occupations and their practices. Groups already finished include attorneys, musicians, bed and breakfast inns, and taxi drivers, just to name a few. The resulting ATGs guidebooks help auditors understand where to look for unreported income in each occupation studied. Currently, there are over 75 guides online at the Internal Revenue Service web site, with new ones being added each year.

Finally, informants often give Internal Revenue Service information on friends, business partners, relatives and especially ex-spouses or boyfriends/girlfriends. Internal Revenue Service will sometimes give a reward for this information.

In the long run, peace of mind is worth more than the taxes due.  If you haven't filed in a while or if you know someone who hasn't filed in a while, now is the time to come back into the system.  It is far better for you to come forward than for the government to come for you!


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