By: A.J. Cook


The Internal Revenue Service is proud of its document-matching program.

As its victims know, IRS computers match forms from banks, securities dealers, employers and others with individual tax returns. This comparing picks up unreported income.

Now some members of Congress want the IRS matching expanded to corporate income. The IRS, less than enthusiastic, says this would be the mother of all nightmares. Like for individuals, banks and other payors would send in reports based on the calendar year paid to corporations. But unlike individuals, many companies end their tax year in a month other than December. Further, companies usually report income when earned rather than when they receive their money. Reconciling the differences in 165 million documents would be no small task for the agency.

The IRS wants to continue finding noncompliance the old fashioned way: auditing manually. Using statistics and electronic equipment to find likely targets, it sends agents out in the field to harvest unreported taxes.

For example, several years ago the IRS decided that bagel bakeries might not be reporting all of their income. The IRS sank its teeth into D & H Bagel Bakery, Inc. and turned up the heat. Using a formula borrowed from General Mills, the IRS measured the number of bagels produced from 100 pounds of flour. It subtracted a number of bagels due to waste, hungry employees eating the final product and returns of stale merchandise to figure that D & H sold 1100 bagels for every 100 pounds of flour it bought. Using prices the bakery charged, the IRS calculated a tax in excess of what D & H had reported.

The bakery did a slow burn over the tax -- not to mention the fraud penalty -- the IRS said it owed. D & H went to court claiming the government should increase the bakery's deductions. It said the agent didn't deduct the cash paid employees. D & H said it, like other bakeries in the industry, paid employees in cash so workers wouldn't have to pay taxes on the full amount of their wages.

The court wouldn't buy that. Further, because the Queens, New York City bakery didn't have any records to disprove the IRS' computations, the judge ruled for the agency.

The Moral:  If you cook the books, the IRS may eat your lunch.

Donald R. Bolton, Sr. of Troutman, N.C., operated a part-time business where he bought scrap metal, processed it and resold it. When the IRS examined his returns, it noticed he hadn't reported any sales from this business for at least four years.

Because Bolton had no records, the IRS was left to its own devices to compute the business' profits. It went to three companies that bought from him and used their figures to estimate sales.

Bolton reminded the agent to deduct the wages paid. Bolton hired people on a day-to-day basis, depending on the work he had and the number of willing workers he could find, and paid them in cash. But when the agent asked for their names, the business owner couldn't recall any.

Bolton took the IRS to court, saying he agreed with the sales amounts, but the wages were wrong. With a sudden memory jolt, he named 25 workers he said he'd paid in cash.

Even so, the court agreed with the IRS figures and its fraud penalty. When the judge asked Bolton why he omitted the income, he said, "I did what most people do in the business and I'm sure you know that most people do the same thing."

The Moral: The business of cheating Uncle Sam can melt down the scrappiest taxpayer.

"In short, and to put it mildly, we find taxpayer's story preposterous," the judge said.

He didn't believe the taxpayer saved $49,000 from gifts through the years and by getting food for his family free from his father's grocery store.

Robert and Kathleen Asmar and their two children lived in Keansburg, N.J. He worked for minimum wages in various jobs until he bought East of Eden, a beauty salon. The Asmars eventually expanded their operations to other businesses including a tavern named Midnight Rambler.

Over a five year period, Asmar made a substantial down payment on a new house, put in a swimming pool, got new furniture, bought a new Buick and a new Cadillac, took his brother with him on vacation to Puerto Rico and bought a new beauty salon with a down payment of $56,103.

The IRS became suspicious because gross income on the Asmars' tax returns averaged less than $16,000 per year. By adding estimated cash expenditures to bank deposits, the IRS determined their income. It figured the couple hadn't reported all their business receipts, so it increased their tax bill and added a fraud penalty.

Robert and Kathleen challenged the estimate of expenditures in court. They never paid full price for things, they explained, like the house, the pool or the trip, and they got groceries free from his father's store. Asmar contended most of the beauty salon payment came from cash gifts from relatives and previously taxed wages saved over many years. He said he had squirreled away $49,000 in a tin box underneath his stepmother's home because he distrusted banks.

But with no witnesses and little or no evidence to support their story, the judge ruled for the government. He said, "We find this explanation unsupported, contradicted by reliable evidence and simply incapable of belief." Funds could not have been available from their nominal tax return income. The judge sarcastically added, "This exercise in frugality is remarkable."

The Moral: Thrift, a commendable habit, is a poor tax defense without records.

With only a high school education and little experience other than a short hitch in the Army, Louis Fragala of Bayshore, Long Island, worked up to civilian chief of a publications branch of the Army Transportation Corps.

Fragala set up a corporation in his wife's maiden name. It wrote manual outlines for Technical Research, Inc., which published booklets purchased by the Army on his recommendation. Technical paid Fragala's company -- but at his request made the checks payable to one of his relatives. The relative cashed the checks and gave the money to him. His subterfuge didn't fool Army officials; he pleaded guilty to defrauding the government and served nine months in jail.

Fragala's troubles continued. The IRS increased his taxable income after reviewing the money he spent in the year examined, including a down payment on a home. He challenged the agency in court explaining the payment came from savings. To contradict this, the IRS said it traced his earnings from high school graduation to date, which showed no opportunity for savings.

The court agreed with the IRS's estimated income and added a fraud penalty. The judge noted that Fragala had no records supporting his theory nor anyone to corroborate it. How could he have saved money, the judge wondered: "Considering the wages he reported and the size of his family, we think that remaining solvent would be primary."

The Moral: When you have no records, the IRS judges your income by what it can uncover.

"I don't keep records, and I don't use a bank account. The IRS can't prove how much I make."

Well, let's see.

Richard S. Sacco worked at several jobs including Buffalo, N.Y., police officer and labor steward for construction companies. On the side he took pictures, of lodges, Little League teams, weddings.

When Richard's Photography Unlimited seemed to develop no taxable income, the Internal Revenue Service got into the picture. Special agents Diane Bloomquist and Roger Rosselli posed as an engaged couple looking for a photographer. When they interviewed Sacco, he said he had photographed weddings for 11 years. He added that he did 28 to 30 a year, charging $250 to $750. "We'll get back with you," the couple promised.

This couldn't be simpler. The agents multiplied 30 weddings by $500, increasing his taxable income by $15,000.

Sacco appealed. In court he said his remarks were only puffery. He said he didn't take pictures for profit; he gave them away or only recovered his cost.

The judge noted Sacco always declared, first to the agents and then in court, what was in his best interest at the time. The court agreed with the IRS computations.

Or consider the case of George Lee Kindred: He made speeches challenging the legality of the income tax system -- and then didn't report his own income.

Kindred, his wife and three children lived on a small farm near Pinckney, Mich. They raised most of their food or traded with neighbors for what they needed.

Kindred traveled throughout the country making speeches about how to beat the system. He said some people filed returns without showing any income; others didn't file at all. Someone always passed the hat for Kindred.

The farmer used cash or money orders for financial transactions and kept no records. IRS agents found no evidence to compute his income, but this didn't stop them. They used the average for a low income five-member family, information gleaned from Department of Labor Statistics.

Kindred went to court accusing the agents of being arbitrary. He complained they didn't consider that sometime he was so broke, neighbors gave his family food and cash.

Without proof of the value of these gifts, the judge refused to consider them. Furthermore, the donations received at the speaking engagements were not gifts but income for tax purposes. As a final blow, the judge accepted the IRS's method of computation saying the agency is allowed "great latitude" when a taxpayer has no records; otherwise," skillful concealment would be an invincible barrier."

The Moral:  It's a jungle out there and without a paper trail, you'll be ambushed by clinging legal binds.


A.J. Cook is a lawyer and CPA. His tax column appears weekly in numerous newspapers. Why isn't it published in your hometown newspaper? Ask its Business Editor to subscribe.

Copyright © 1987-2001 A.J. Cook All Rights Reserved
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Released 7-15-91, 9-23-91 and 7-12-93