Tax Fraud Defense and Forensic Accountants

Government investigations of white collar crimes almost always have one thing in common: They rely heavily on the analysis of financial information. Often, this includes combing through bank statements and credit card statements, as well as scrutinizing accounting records.

Some people think that analyzing this kind of data is simple. It seems like it is only a math exercise in which we’re checking dollar amounts and verifying the addition and subtraction. But there is much more involved, and it gets exponentially more complicated (pun intended) when there are large volumes of data.

Expertise in financial and accounting crimes is necessary to fully understand the issues and the potential criminal or civil charges that the government brings against a company or individual. To properly defend such a case, it is necessary to have a forensic accountant involved to help evaluate the data and the issues the government will raise.

Without a forensic accountant or fraud investigator, the defendant is left at the mercy of the government’s investigators, and they can hardly be trusted to do a fair and accurate analysis of the numbers. Simply put, the government has a vested interest in making the numbers related to the crime or civil infraction as large as possible so as to encourage guilty pleas or settlements.

I’m not saying that government investigators are dishonest. Rather, I am saying that they are not looking out for the best interest of the accused. Their interest is the government and whatever civil or criminal penalties the government is seeking. For that reason alone, their work must be viewed skeptically with the assistance of someone as knowledgeable as the government’s employees.

Consider allegations of tax fraud. When the Internal Revenue Service suspects a taxpayer, either a business or individual, is substantially underreporting income for tax purposes, bank documentation is one of the key pieces of their investigation. The investigator will subpoena bank statements, check copies, and deposit detail, and scrutinize these documents to ultimately calculate unreported income.

The criminal investigator or revenue agent is looking at the bank documents to identify a number of things:

• Is more money being deposited into bank accounts than is being reported as gross income?
• Does spending appear to be in excess of the income reported?
• Is there evidence of other bank or brokerage accounts that could provide valuable clues about the taxpayer’s income?
• Are there any transactions involving overseas accounts that may be used to hide income?
• Do the bank records suggest that crimes such as money laundering, organized crime, or terrorist financing are occurring?

Documents evidencing expenditures, asset ownership, and movement of money will be scrutinized as well. When there is a question about whether or not funds represent taxable income, i is no coincidence that a government investigator tends to decide the issue in the government’s favor. If the taxpayer cannot prove that an item is not taxable, then the government will usually assume that it is taxable.

In lieu of direct evidence of income and deductions, the taxing authorities will turn to alternative methods of proving income. Indirect methods of proof include the Net Worth Method and the Expenditures Method, both of which can also be referred to as a lifestyle analysis. Essentially, the government is examining known assets and expenditures to back into the amount of pretax income needed to pay for those items.

In one criminal tax fraud case, the IRS alleged that a small business had several hundreds of thousands of dollars of unreported income. Their analysis has several major flaws, but it took a forensic accountant to pick apart the numbers and find the fallacies in the government’s assumptions. A lifestyle analysis performed by the forensic accountant further showed that the government’s numbers could not be true based on the assets and expenditures of the owners. The actual unreported income was a small fraction of that alleged by the government, and the results of the detailed financial analysis were presented to the government and aided in a substantially smaller settlement paid by the taxpayers.

Properly defending a tax fraud case of this nature requires a forensic accountant who has the ability to capture and analyze the data, complete a proper independent analysis of the “lifestyle” of the business or individual, and poke holes in the government’s analysis, calculations, and conclusions. The documentation is often voluminous, which is why it is imperative to engage an investigator who has a track record of successfully completing such cases. Innovations in technology can help manage and analyze reams of data, but it is equally important to have an expert who is well-versed in this type of complex analysis.

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