The bank deposit analysis is essential to every single IRS audit.
A bank deposit analysis is where the IRS will analyze, all the deposits coming into a bank account that you own, either personal or business, and determine whether those deposits are taxable or non-taxable income.
As you can imagine, if you’re depositing cash, it’s hard to tell the source of that money whether you sold a car or whether you got paid for work that you’ve done. So, your obligation as a taxpayer or business owner is to establish the origin of income with some kind of documentation supporting whether the deposit was non-taxable income.
Sources of Income
For instance, if you took money from your credit line and had the money transferred into your bank account, or if you receive money from escrow it may be hard to tell what the source of that income was and whether it should be taxable income.
On the other hand, if you got a check that was deposited, and IRS shows you a copy of that check image, you may be able to easily determine whether it was taxable or non-taxable. And if you can’t, on the face of the check, you can reach out to the person who wrote you the check to verify what the source of the income was and why you received that money.
The Bank Deposit Analysis is an essential part of every single IRS audit because determining income is essential to every single IRS audit. When the IRS has concluded its bank deposit analysis it should prepare a work paper and give you a total. The work paper will compare the bank deposit analysis total to what you reported on your tax return. If the two differ, especially if there is an increase, IRS will then assess you additional taxes, based upon that increase in income. Additionally, they will do this for every year of the audit.
If IRS only opens up the first year for audit as a test year and you have unreported income, typically IRS will open up additional years. If the amount of unreported income is insignificant or de minimus, then it’s not as critical. They may not conclude that the same errors are occurring in other years.
Be Careful with Cash
So, in the event of an IRS audit, it is wise to spend a lot of time on the bank deposit analysis. Keep good records, especially if you’re depositing cash. It’s really hard to trace cash and tell what the source of that was. So, keep good records when you make a deposit. Have photocopies of the checks you deposit and if you have cash, make a note as to where the cash came from. If there is a contract or you sold a car, just make a note as to how you got the cash and that could help explain and potentially resolve any issue with IRS.