In year 3 your client’s year 1 return is being examined. Unfortunately, he doesn’t maintain adequate books and records prompting the Revenue Agent to conduct an indirect method examination, bank deposit analysis. Note that the inadequate records provided reasonable indication that he may have underreported income.

In year 3 your client’s year 1 return is being examined. Unfortunately, he doesn’t maintain adequate books and records prompting the Revenue Agent to conduct an indirect method examination, bank deposit analysis. Note that the inadequate records provided reasonable indication that he may have underreported income. The Revenue Agent has determined the cash on hand at the beginning and ending of the tax year. As it turns out she has identified 5 sizable deposits to your client’s checking account totaling in excess of $40,000 which your client is unable to prove the source of the funds. Is this evidence sufficient to prevail on the unreported income issue and the civil fraud penalty?
Select the best answer:

A.
Yes, unreported deposits from an income producing source is sufficient not only to establish unreported income but also to prove fraud by clear and convincing evidence.

B.
No, while the government may have determined unreported income, it has yet to establish by clear and convincing evidence that your client’s underreporting is attributable to fraud.

C.
Yes, the unreported deposits will automatically result in the assertion of the civil fraud penalty and criminal indictment as well.

D.
No, the government will lose the unreported income since it cannot prove that the deposit wasn’t from a non-taxable source. As such, the government will not prevail on the unreported income or the penalty.

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