The IRS will often assert the ‘bank deposits’ method of reconstructing the gross income of a taxpayer when conducting an examination. Under this method, the taxpayer’s bank deposits are considered proof of the taxpayer’s income. This analysis is usually utilized by the IRS when the taxpayer is unable or unwilling to provide adequate books and records to otherwise determine the taxpayer’s income.
This approach was validated again in a recent Tax Court case, where the taxpayers represented themselves against the IRS. The IRS was able to demonstrate that the taxpayers had bank deposits that greatly exceeded the income reported by the taxpayers on their tax return. Because of this, the burden shifted to the taxpayers to show that their bank deposits did not include unreported income. When the taxpayers were not prepared to provide sufficient documentation for their analysis, the IRS was successful in asserting liability.
The case again demonstrates the importance of keeping adequate books and records, and of obtaining competent representation in an examination. If you or your business is undergoing an examination by the IRS, please contact David Guarino or Cory Bilodeau, the Co-Chairs of the Tax Practice at Fletcher Tilton. Click here for a printable pdf.