Question

What are the three (3) methods of proof that the IRS would use to show the taxpayer has
understated his or her income?

Answer 1

The three methods of proof are:

1. Direct (specific item) method – This method will focus on specific financial transactions that support either unreported or underreported income. The focus is given on all direct evidences of income that has been received by an individual in a tax year. The steps to establish a specific items case of unreported income begins with IRS showing that the underreported/unreported amount is taxable, showing that the amount has been received by the individual, showing that the income was not reported and lastly showing that the individual in question was personally involved in the failure to report this income.

2. Indirect method – This method requires that special agent has to gather and then present evidence to support the allegation that income has been understated. The special agent, in such cases, will use evidence to determine what all incomes should have been reported. This will then be compared to the amount that has actually been shown on the return.

3. Net worth method of proof – This method makes use of evidence of income applications such as accumulation of assets, reduction of liabilities, expenses, and other such financial data that can be used to establish the correct amount of taxable income.