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How to prepare an IRS Bank Deposit Analysis

How to prepare an IRS Bank Deposit Analysis

The bank deposit analysis is essential to every single IRS audit. 

An IRS Bank Deposit Analysis is a tool used by the Internal Revenue Service (IRS) to help determine whether an individual or business has accurately reported their income on their tax returns. Preparing an IRS Bank Deposit Analysis involves gathering and organizing financial records, including bank statements and other documentation of deposits made into your account(s). 

This process can be time-consuming and may require some effort, but it is important to accurately report your income to the IRS to avoid potential penalties and fines.

In this article, we will provide an overview of the steps involved in preparing an IRS Bank Deposit Analysis and offer some tips for making the process as smooth as possible. Let’s begin with reviewing what an IRS bank deposit analysis includes.

What is an IRS Bank Deposit Analysis?

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. 

It can be difficult to determine the source of cash deposits, as it is not always clear whether the money was received from the sale of a car or from wages earned through work. As a taxpayer or business owner, it is your responsibility to provide documentation to establish the origin of income and determine whether the deposit is considered non-taxable. It is important to accurately report all income to the Internal Revenue Service (IRS) to avoid potential penalties and fines.

How to Start Preparing for an IRS Bank Deposit Analysis

Here are some steps you can follow to prepare an IRS Bank Deposit Analysis:

Gather financial records: Start by gathering all relevant financial records, including bank statements and any other documentation of deposits made into your account(s). This may include pay stubs, invoices, receipts, and other documentation that supports the sources of the deposits.

Organize the records: Next, organize the records in a way that makes it easy to review and analyze the deposits. This may involve sorting the records by account, timeframe, or source.

Calculate the total deposits: Using the financial records, calculate the total amount of deposits made into the account(s) being analyzed.

Identify the sources of the deposits: Determine the sources of the deposits, such as wages, self-employment income, rents, and other sources.

Determine the taxability of the deposits: Review the documentation provided and consider the taxability of the deposits based on the source of the funds and any applicable tax laws.

Prepare the analysis: Using the information gathered, prepare the IRS Bank Deposit Analysis by completing all relevant sections, including a summary of deposits, a breakdown of deposits by source and account, and any supporting documentation.

The IRS Bank Deposit Analysis Process: How It Works

Let’s dive into the key considerations surrounding the IRS Bank Deposit Analysis process. This includes an overview of how the process operates, as well as the types of information that may be requested from taxpayers in the course of the analysis.

Sources of Income

It may be difficult to determine the source and taxability of certain types of income, such as funds transferred from a credit line or money received from escrow. In these cases, it may be necessary to provide additional documentation or seek clarification from the source of the funds to establish the origin of the income and determine its taxability. 

If you receive a check and a copy of it from the IRS, you can use the information on the check to understand where the money is coming from and whether or not it is taxable. It might be helpful to contact the person who wrote the check to confirm the source of the income and why you received it.

Determining Income

The Bank Deposit Analysis is an essential part of every single IRS audit because determining income is essential to every single IRS audit. 

Upon completion of the IRS Bank Deposit Analysis, the IRS will prepare a work paper that compares the total deposits identified in the analysis to the income reported on the individual or business’s tax return. If there is a discrepancy between the two, especially if there is an increase in the total deposits, the IRS may assess additional taxes based on the increase in income. 

This process may be repeated for each year being audited. It is important to accurately report all income on tax returns to avoid potential assessments of additional taxes and penalties.

Additional Years

If IRS selects the first year for audit as a test year and discovers unreported income, it is likely that additional years will also be audited. However, if the amount of unreported income is relatively small or insignificant, IRS may not conclude that the same errors are occurring in other years. It is important to accurately report all income on tax returns to avoid potential assessments of additional taxes and penalties.

Be Careful with Cash

During an IRS audit, it is advisable to devote significant attention to the Bank Deposit Analysis and maintain thorough records, particularly when depositing cash. It can be difficult to trace the source of cash deposits, so it is important to document the origin of the funds through photocopies of checks, contracts, or other relevant documentation. 

Additionally, making a note of the source of cash deposits, such as the sale of a car or the receipt of a contract payment, can help to explain and potentially resolve any issues with the IRS. Accurate record-keeping is crucial in the event of an IRS audit to ensure that all income is accurately reported and to avoid potential assessments of additional taxes and penalties.

Still Have Questions?

Business owners should contact Milikowsky Tax Law if they have any additional questions about how to navigate the IRS audit process.

At Milikowsky Tax Law, we have over a decade of experience working with IRS and tax audits. We’re experts in defending business owners in the face of IRS or other government agency audits.

Interested in learning more? Read on to learn how to respond to an IRS audit.