The IRS has expanded its audits to investigate the financial lifestyle of the taxpayer, rather than just verifying income and expenses reported on the tax return.

One of the main goals of a financial status audit is to determine whether all income has been reported. Is the income reported on the tax return enough for the taxpayer to live on? Is it enough to buy the purchases and investments made during the year?

ECONOMIC REALITY

The tax returns are audited from an economic reality viewpoint. Can the taxpayer finance his/her lifestyle with the income reported on the tax return?

Information concerning a taxpayer such as credit reports, records of property purchased and sold, automobile-boat-plane registrations, and 1099s issued will already be gathered by the auditor before the initial meeting.

The auditor will question the taxpayer's lifestyle and living expenses by analyzing the taxpayer's:

• Standard of Living
• Accumulated Wealth
• Economic History
• Business Environment

• Address/neighborhood of the taxpayer
• Number and age of dependents
• Investment income, trusts
• Assets purchased
• Home furnishings and fixtures
• Recreational vehicles and autos
• College tuition and support payments for students
• Professional and business licenses
• Trips and vacations taken
• Use of credit/interest expense
• Club memberships, hobbies/toys
• Weddings for children
• Insurance coverage/what is covered
• Cultural background and education of taxpayers
• Bank accounts (foreign/domestic)
• Nontaxable sources of income
• Sales of property and other assets

Net worth - A taxpayer must report enough income to cover an increase in net worth, but also to pay for daily family living expenses.

Bank Deposit Analysis - At the end of the year the total bank deposits should match the income being reported on the tax return. If there are unexplained deposits, the auditor will assume this is unreported income.

Source and Application - This method compares the amount spent for the year to the amount earned to see if the taxpayer has unreported income. Are you reporting enough cash coming in to finance the amount of cash going out?

Percentage Computation - The auditor will take the items purchased for resale and use a standard mark up to determine what the sales should have been.

BE PREPARED

When you are gathering your data to prepare your income tax return, you may want to take a look at your data from the same viewpoint of the auditor.

If your analysis leads you to believe your data may be in question, you should do the following:

Recheck your data. Maybe you have omitted something that should be included.

Make sure you have good records to support your data in case of an audit.

Keep in mind, the burden of proof rests with the taxpayer.

This is general tax information. Each business situation may be different. This information should not be relied upon as your source of authority. Please seek professional advice for all tax and payroll situations.