Credit Application Establishes Income

As a general rule, all income “from whatever source derived” is taxable. Some taxpayers, however, fail to report some or even all of their income. Some taxpayers do so because of an oversight or misunderstanding of tax rules; others because they choose not to report their income. Underreported income is particularly problematic with those in cash businesses. The IRS has the authority to reconstruct income when it has not been reported.

The IRS uses various methods of reconstructing income, including:

• Combining a taxpayer’s known expenses with cost-of-living estimates presented by the Bureau of Labor Statistics.
• A taxpayer’s self-reported income on a loan application (such as for a mortgage or a credit card).

Bottom line: The IRS’s reconstructed income may be more than a taxpayer’s actual income.

Source: Carol Trescott; T.C. Memo. 2012-321