IRS Net Worth Audit

Among the government's most powerful weapons to prove unreported income is the net worth method of proof.

"The IRS will typically undertake a net worth investigation when one or more of the following conditions exist: the taxpayer maintains no books and records; the books and records are not available; the books and records are inadequate; or the taxpayer withholds his books and records."

This method of proving unreported income, often used in tax evasion and civil fraud cases, is one of a number of methods that assume that the taxpayer has hidden his income; therefore, true income cannot be proven directly.

Every item of the special agent's or revenue agent's report must be analyzed in great detail and dissected for correctness. Every time an error is found, the trustworthiness of this inherently untrustworthy method is called further into question.

The method, shaky to start, may be discredited by proving as few as one, or perhaps two or three, significant errors. Moreover, small errors may be combined to add up to major holes in the government's case.

IRS Net Worth Audit Attention to detail is the key to combating a net worth case.

The basic net worth formula is as follows:

  • STEP 1 - Net worth end of year - net worth beginning of year = increase in net worth;
  • STEP 2 - Increase in net worth + nondeductible expenditures - nontaxable income = adjusted gross income; and
  • STEP 3 - Adjusted gross income - adjusted gross income per return = understatement of adjusted gross income.