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5.1.30.6
(09-21-2007)
Strategic Approach Case Example – Economic Reality
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In this type of case, the taxpayer has provided a CIS but the lifestyle of the taxpayer indicates higher available income
or equity than indicated on the CIS provided.
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Some situations you might encounter are:
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These situations can be the result of:
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Unreported income
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Inflated expenses
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Fraudulent claims against assets
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A recent significant reduction in available income
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Living beyond current income from credit
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If your analysis shows that the taxpayer is simply spending more than income earned based on such indicators as unusually
high credit card balances and late payments, follow the directions for necessary and allowable expense guidelines found in
IRM 5.15, Financial Analysis.
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If the taxpayer is able to regularly pay monthly obligations in excess of the reported income, additional verification of
income is necessary. Cross check income shown on the CIS by comparing it to the income reported on the latest tax return and
the income deposited into the taxpayer’s bank account. Ask the taxpayer to explain any discrepancies. If no reasonable explanation
is offered, ask the taxpayer to pay based on the amount of income identified. Consider an exam or fraud referral if the undisclosed
income is also unreported and is significant.
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For other cases with no obvious reason for the discrepancy, a more detailed and in depth verification of the CIS may be warranted.
Factors to consider in making this decision include the amount of the discrepancy, the tax liability, and compliance impact.
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Consider the use of ratios to determine the taxpayer's ability to pay the liability. Ratios can also be used to determine
the ability of the taxpayer's business to survive over a long period of time and how well the taxpayer is conducting their
business. Additional information on ratios can be found on the Investigative Techniques and Sources web site by clicking
on "Tools to Use"
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If the location of the bank account(s) is known, complete an in-depth bank analysis:
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Request copies or summons bank statements that will capture several months of activity.
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Request or summons a sampling of deposits and checks.
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Examine deposit slips to determine if all money actually was deposited into the bank account.
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IRM 5.20.4-1 through 5.20.4-8, Summons Procedures, contains several examples of suggested summons language.
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How many checks or deposited items are needed is determined by the facts of the individual case. There are several different
suggested methods for summoning credit and debit material for a bank analysis. For example:
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Request copies of checks and deposits over a specific dollar amount
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Request all checks and deposits for a one to three month statement period
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Select specific checks and deposits from the bank statements. Follow up with a second summons for these items or include language
in the initial summons that indicates you will contact the bank after the statements are received in order to identify the
specific checks and deposits.
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Consider the possible cost of the summons and whether the cost is prohibitive relative to the liabilities to be collected
or the compliance issues involved.
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When reviewing the bank statements and supporting documents look for unusual occurrences or patterns such as the following:
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Large, unexplained deposits could serve to identify undisclosed income.
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Transfer of funds in either even dollar amounts or in large amounts to or from another financial institution could indicate
an undisclosed bank account.
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Transfer of funds in either even dollar amounts or in large amounts to or from other accounts in the same financial institution
without disclosing the ownership of the funds.
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Unexplained deposits being made on a regular basis. These could indicate an undisclosed income source such as rental income.
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Checks made payable to cash in any amounts, but especially ones cashed on a regular basis or in large dollar amounts.
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Large and frequent ATM withdrawals in cash.
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Checks issued in regular amounts on a monthly basis to an unknown creditor. For example, checks that are written on a business
account that may be used to pay a personal home mortgage and/or automobile loan/lease payment.
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Groups of checks and/or deposits which occur around the same time and are out of the ordinary business pattern.
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Checks or electronic payments which are not made for an ordinary business purpose. For example, a payment from a corporate
account to a cable TV provider or to a hair salon. Payments of personal expenses from a corporate account are an indication
of a possible alter ego.
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These are indications that require further investigation in order to verify the asset and income information included on the
CIS. Determine if additional research should be conducted through third parties or if the taxpayer should be asked to provide
an explanation. If the taxpayer cannot provide a reasonable explanation, proceed with additional summonses to establish sufficient
proof of the taxpayer’s interest in the income and/or assets.
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Locating the Bank Account(s):
If a CIS cannot be secured or if a bank account is not provided, the revenue officer needs to take steps to locate the bank
account. To do this the revenue officer should examine payments made to the taxpayer or payments made by the taxpayer, and
use those payments as a starting point for locating assets and identifying links to assets or cash flow. An example of this
would be summoning a credit card company for a copy of the payment made by the taxpayer to identify the taxpayer's bank account.
From that starting point the funds can be traced forward to obtain current information. Though the credit card payment may
be several months old, a summons to the taxpayer's bank will yield more current financial information.
Examples of payments made by the taxpayer include payments for:
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Mortgage
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Property taxes
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Rent
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Car loan
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Utilities
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Credit Cards
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Suppliers
Examples of payments made to the taxpayer include:
Once a bank account is located, follow the suggested steps above in order to analyze that information.
Note:
You can summon information from a bank account that is not held in the name of the taxpayer if you have identified a potential
nominee, transferee, or alter-ego connection to the account. This may include income earned by the taxpayer being deposited
into the account or the taxpayer writing checks from the account. Be specific in your instructions on the summons by listing
the account number and be sure to explain in your case history the connection to this account. Like all third-party summonses,
managerial approval is required. While the summons only requires managerial approval, levy action under nominee, alter-ego,
or transferee doctrine requires written approval by Area or Associate Counsel. See IRM 5.11.1.2.5, Approval of Alter-Ego and Nominee Notices of Levy, for more information on levies under nominee, alter-ego, and transferee doctrine.
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Other factors to consider:
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If the taxpayer is receiving the benefits of an asset held by a third-party, such as, living in a house owned by a business
entity they control and not paying any rent, there may be a nominee issue that needs to be developed.
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If there are encumbrances against property but no payments being made and these significantly reduce or eliminate any equity,
verify that something of equal value, such as a loan, was given for the encumbrance.
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If the beneficiary of an encumbrance on the taxpayer’s property is closely related to the taxpayer or controlled by the taxpayer,
verify that value was given for the encumbrance.
These things are indications of hidden property interest, but are indications only. Further investigation is needed to prove
the undisclosed interests of the taxpayers. Consult IRM 5.17, Legal Reference Guide for Revenue Officers, and local Area Counsel for assistance with using the legal theories of nominee, alter ego and transferee to move against
property held in the name of third parties.
Unreported income and hidden property interests are indications of fraud. If the amount of the liability warrants it, consult
with the fraud technical advisor.
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