Tax Investigation Basics

Having to experience a tax investigation by the HMRC is likely to be a difficult and costly process. It is highly likely to be expensive, intrusive, and disruptive for any business that this action might impact. Many of these cases can last for a good 12 to 18 months which can be very inconvenient for the everyday operation of the business.

An initial tax investigation might be started for several different reasons, which might relate to anomalies, innocent mistakes, or similar such information on the tax returns. A tax investigation might be started in situations of the HMRC receiving a tip-off. Although, the tax authorities have the right to choose anyone for an inspection on an entirely random basis, which means that every taxpayer is open to this process.

In those situations of receiving a letter from the tax authorities it is important to respond to the any enquiries as soon as possible to help with resolving the concerns. It is always necessary to engage with the HMRC as soon as possible. The worse thing that can be done in a situation of this nature is to just ignore the letter received. This is only likely to mean that things get worse and more complicated in the future. There is a greater risk of being prosecuted or receiving a negative outcome if you aren’t willing to actively engage and respond to the requests made by the HMRC. Even in situations where you believe that nothing is wrong it is still necessary go through the process for providing the information required to prove complete innocence.

A full tax investigation is certain to be very distracting and intrusive and can impact on the day-to-day operation of the business. In an attempt to limit some of the disruption experienced it often benefits to rely on the services of independent specialists who are able to give guidance on the best course of action to take. Even though it might cost more to get the professional guidance you will be often find that these specialists are able make the entire process that much less painful.

All in all, if you are able to take the necessary action as soon as possible after receiving the notification in the post you should find that the tax investigation is able to progress that much smooth, and hopefully you are able to get the outcome that you are hoping to achieve.

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Tax Investigations and Methods Used During Investigations

Income tax returns filed by taxpayers are often incorrect. Sometimes they are incorrect due to simple mistakes, accidents, oversight, confusion, or misunderstanding of the law. Sometimes they incorrect due to gross negligence or reckless disregard of the law. And, sometimes they are incorrect because the taxpayer willfully and knowingly intended them to be incorrect in order to purposely pay less income tax. No matter what the reason, when incorrect returns are identified, they must be corrected, either immediately, or after the conclusion of any criminal proceedings that might be undertaken.

When tax inspectors or investigators confront taxpayers to inquire why the income tax return is incorrect and seek their cooperation to rectify it, the taxpayer will either be cooperative or not. When the taxpayer cooperates, it becomes much easier to determine how much true income the taxpayer earned, or which expenditures are truly allowable under the law, in order to arrive at the correct amount of tax. Cooperative taxpayers may provide their books and records or other documents, and assist the inspector or investigator as he attempts to determine how much additional income tax the taxpayer should pay.

When taxpayers do not cooperate, the inspector, or investigator, can be confronted with a serious dilemma. How can they determine how much additional income tax the taxpayer should pay, if any. They must resort to other methods to obtain the information necessary to calculate the true tax due from the taxpayer.

During a tax criminal investigation, the investigator is required to identify the amount of income that is not reported on the income tax return, and also identify any expenditures that are on the income tax return that are not allowed by law to be included on the return. It is usually not possible to be exact in determining the amount of income, nor is it necessary to identify the exact amount of unreported income. The amount not reported must be substantial, in relation to the amount reported, if any. Small cases, where minor amounts of income are not reported, are not the type of cases the tax investigator should identify and investigate. The tax investigator should always be alert to major cases using the criteria, in order to identify and document the amount of income that is not reported, or to identify expenditures not allowed by law that have been deducted on the tax return, the investigator must identify and gather evidence. This is not an easy task. When taxpayers do not cooperate, it becomes a very difficult task.

In the world of financial investigation, there are methods and techniques available for the investigator to actually re-calculate or reconstruct the taxpayer’s true income and expenses, even without his cooperation, or even without his books and records. In fact, as the tax investigator enters the world of criminal justice, where taxpayer engages in fraud, and could therefore could face imprisonment, it is highly likely that taxpayers will cooperate less. Therefore, the tax investigator must become skilled in the use of the techniques available to re-calculate or reconstruct a taxpayer’s income and expenses.

However, before these methods are explained, the investigator must fully understand what an income tax return represents, and how it relates to the taxpayer’s books of account, commonly called books and records. The section that follows explains how the daily business activities of buying and selling relate to an income tax return. Although this section may appear to be elementary or basic, a review of the nature of an income tax return will clarify the use of the Specific Transaction Method of Reconstructing Income, the most common and effective method available to reconstruct a taxpayer’s income, when the taxpayer does not cooperate.

Income tax returns filed by taxpayers are required by the Income Tax Law to contain a summary of all financial transactions the taxpayer engaged in during the tax year. The summary should include all transactions where the taxpayer incurred an expense or other deduction allowed by law through an outlay or expenditure of funds. It should also include all transactions where the taxpayer received or otherwise earned money from selling a product or service.

In general, when the total of all transactions where funds were received exceed the total of all transactions where funds were expended, the taxpayer has a net profit, which is the amount upon which the tax is based. When the total of all transactions where funds were expended exceed the total of all transactions where funds were received, the taxpayer has incurred a net loss, and no tax is required to be paid.

Of course, each specific expenditure must be allowable under the law in order to be included on the income tax return, and each specific receipt of funds must be taxable under the law in order to be required to be reported on the income tax return. Expenditures incurred that are not allowable under the tax laws should still be reported in the taxpayer’s books and records, but must not be included on the income tax return. Similarly, the receipt of funds that are not classified as funds subject to tax, should be reported in the books and records of the business, but not included on the income tax return.

In addition, under the accrual method of accounting for expenses and earnings, some expense items may be included on the income tax return even though no actual expenditure was made, and some items may be included as income, even though no funds were actually received.

If the taxpayer engages in specific financial transactions during the year that are required to be included within the summary of expenditures and receipts, but are not, then the income tax return is incorrect.

For example, if the taxpayer engages in a financial transaction where he sells a product or service but does not report the receipt as gross income or gross revenue, then the income tax return is incorrect. Similarly, if a taxpayer includes on his income tax return a financial transaction where funds were expended on a product or service that is not allowed to be deducted under the tax law, the return is also incorrect.

The income tax return is required by law to include all specific financial transactions related to determining a profit of loss. When certain, specific transaction are not included, the tax investigator must be able to identify which specific transactions were not included, and seek to gather evidence of the source and amounts required to be included. Identifying which specific transactions were not properly reported is known as the Specific Transaction Method.

Other methods of re-calculating or reconstructing a taxpayer’s true net profit or loss are based on the sum total, or aggregate of all transactions the taxpayer engaged in during the year. These methods do not identify specific transactions of buying and selling. Instead, the net profit is calculated or reconstructed based on the total of all expenditures made, or the total of all funds deposited into bank accounts.

One such method is known as the Net worth Method. This method measures the increases in a taxpayer’s net worth between years. Net worth is the amount of assets a taxpayer has accumulated that exceed the amount of liabilities he has accumulated. Increases in net worth are the result of the taxpayer spending money to increase the amount of assets he has, or to reduce the amount of debt he has. In addition, a taxpayer’s expenditures that have no lasting value, or do not increase assets, such as expenditures for costly airline tickets for personal vacations, are identified and added to his increase in net worth.

The increase in net worth from one year to another is compared to the amount of income reported on the income tax return. Increases greater than the amount of income reported can be attributable to the taxpayer failing to report all his income, because no one can spend more than he earns. The excess is charged to the taxpayer as unreported income. Of course, adjustments must be made, as described in the text that follows, for loans, gifts, inheritances, and other sources of funds that are not taxable.

Another method is known as the Bank Deposit Method. This method compares the total amount of funds deposited into all bank accounts during the year with the gross receipts reported by the taxpayer on his income tax return. Bank deposits that exceed gross receipts are charged to the taxpayer as unreported income. Again, certain adjustments must be made, and other requirements must be met before the excess can be called unreported income.

The Specific Transaction Method is the most commonly used method and the most easily understood.

All three methods, however, have one common thread. All three require the tax investigator to follow the flow of money, from one person to another. This is accomplished by following the paper trail that financial transactions leave. When products are sold, goods are purchased to be consumed in the course of business, or when services are provided, often based on a contract, records generally exist that reflect the nature of the transaction, particularly if the amounts are large. Such records include purchase orders, sales receipts, inventory lists, invoices, deposit slips, bank statements, etc. By following the money, the tax investigators will encounter individuals who can become witnesses who will ultimately produce the evidence the investigator needs to document his case and establish the taxpayer committed a crime under the Income Tax Law.

Smaller businesses may not maintain books and records, which would increase the difficulty of addressing non-compliance. Other methods are available to address these types of taxpayers. One common method is to impose an annual license fee on small businesses, instead of requiring an income tax return. Such a method greatly reduces the administrative burden necessary to collect a small sum of income tax.

The Tax Honesty Movement

The tax honesty movement (THM) is not a person or a single organization. The THM is a belief or way of thinking based upon freedom and accountability. The term “The Tax Honesty Movement” was coined in the mid 1990’s, by an unknown author, to describe this growing segment of our society. There are some who have studied tax law, the Constitution, and Supreme Court tax cases, and have come to the conclusion that not everyone is subject to individual income tax. But more to the point is that they desire our government to answer the questions posed to them to show where the law makes the ordinary citizen liable for that tax and where in the Constitution they derive that power. This belief is founded upon the fact that Americans, as the rightful and just sovereigns of this nation, demand an open transparent government that is answerable to them, their creator, “We the People”. In particular – honesty by the government on issues relating to taxation of the American people.

There are some who may be shocked to learn that the income tax, which is applied to people’s wages, is a rather recent occurrence in American history. For the first 150 years of our nation there was no income tax. In fact, the first few times the government tried to enact such a scheme, the Supreme Court found it unconstitutional (1850-1913). If it was unconstitutional then, why is it constitutional now?

In the late 1800’s and early 1900’s, there were a number of corporate tax cases which ruled what was and what was not “income.” In general the government can only tax via two methods – either directly or indirectly. Article 1, Section 9, of the Constitution says a direct tax is a tax that is levied directly upon a person or property, and therefore, it must be apportioned among the states based on the states population. (A primary reason we have a national census.) An indirect tax is levied upon a privilege or an action, such as a corporation, or a sales tax on certain products or business.

Congress passed the Income Tax Act of 1894 which taxed rental income from real estate. In 1895, the Supreme Court ruled the act unconstitutional, as it was a direct tax and must be apportioned.

In 1913 Congress passed the Sixteenth Amendment which authorized taxation of incomes without apportionment. To which incomes did this relate? As with all things in the legal world, context is everything; in the 1943 case of Halvering V. Edison Bros. Stores, the court stated that neither the Treasury Department nor Congress could “tax as income that which is not income within the meaning of the 16th Amendment.”

What then is 16th Amendment income? In Corn V Fort, the court ruled “The individual, unlike the corporation, cannot be taxed for the privilege of existing”, and “the individuals Right to live and own property are natural rights for the enjoyment of which an excise cannot be imposed.” In Stratton’s Independence, LTD V. Howbert, 1913, the Supreme Court stated that the 1909 corporate Tax Act “was an excise tax upon the conduct of business in a corporate capacity… measuring however, the amount of tax by the income of the corporation.” Also, in the 1921 case of Merchants’ Loan & Trust Co. V Smietanka the court stated, the word income must be given the same meaning in ALL income tax legislation as was given in the Corporate Tax Act of 1909. This being the case all “income” tax is based on “corporate” income. Within the 1909 Corporation Tax Law (Chap. 6, 36 stat. 11), it states that the income tax was levied “with respect to the carrying on or doing business by such a corporation…” It is therefore settled that 16th Amendment income must deal with corporate income. As wages are a person’s property, and the right to work and own property cannot be taxed without apportionment, the direct tax against individual wages is unconstitutional.

There is also the question of WHO is made liable by the tax code. In Economy Plumbing and Heating Co. V United States, the Courts have stated that the revenue laws “relate to taxpayers, and not to nontaxpayers.” Because Congress does not deal with nontaxpayers, their laws only cover those who ARE taxpayers. Therefore, you will never see any code which says what is not subject to tax, only what is subject to tax. This case shows that there are persons who are NOT taxpayers; how then do we know if we are one of them?

According to the IRS code for the taxpayer, taxes are paid on “wages” for “services performed by an employee for his employer.” This sounds straight forward enough; But what is an employee? According to the IRS code Title 26, Subtitle C, Chapter 34, Section 3401, “Employee includes an officer, employee, or elected official of the United States, a state, any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any one or more of the foregoing. The term “employee” also includes an officer of a corporation.” Based on the IRS’s definition for employee, are you an employee? Most of us are not. If wages are earned by employees; and you are not by definition an employee, then you are not a taxpayer (unless you volunteer to be one.)

As most of us do not earn “income” nor are we “employees”, as defined by the IRS’s own code; we should, therefore, not be subject to the tax. This short article cannot cover every aspect of the THM, but these examples illustrate the points which the THM endeavors to resolve, honesty between the government and the citizen. As we can see from the examples above, our laws are so convoluted, misleading, and vague, that the ordinary citizen may not be able to discern who is and who is not liable for the tax. The THM simply desires the government to answer such questions honestly and directly. As Citizens, we deserve nothing less.

The First Amendment states, “…and to petition the government for a redress of grievances.” This right requires the servant government to answer the people’s questions when they feel they have been wronged. Petition of redress goes beyond the history of our own government, as it was used by our founders to receive answers from the King of England to try and right the wrongs of the early colonists. However, history may be repeating itself. One of the primary reasons for our withdrawal from England, as stated in the Declaration of Independence, was: “In every stage of these oppressions we have petitioned for redress in the most humble terms: our repeated petitions have been answered only by repeated injury.”

In 2001 a group of THM leaders led by Mr. Robert Schulz from “We the People Foundation”, and others from around the country, coordinated a meeting with the IRS, members of the Department of Justice, and a member of Congress to discuss their grievances concerning individual taxes and tax law. It was agreed upon by all parties, the date was set, and it was even arranged to be web-cast live and recorded for posterity. A shrewd lawyer from the government decided they had better have a look at which questions would be asked at this forum, so they were provided a list of 299 questions. The government has consistently stated that the arguments of the THM are frivolous and without merit. They now had the opportunity deliver a knock-out blow and to crush every argument once and for all. Within a week of receiving the questions, the government stated they would not be attending the meeting; and they gave no other reasons.

When Robert Schultz and the “We the People Foundation” asked why the government would not answer their questions, the government’s response was silence. Later, when the Treasury department was asked on camera why they did not answer the petition, they responded that they would answer the petition by enforcement. Meaning, they would use force against the people of the United States to make them comply. Mr. Schultz then brought suit against the United States to gain resolution to his petition. This case has risen to the Supreme Court to decide if the government has an obligation to answer the petition of the people. Currently the Supreme Court is deciding if they will accept the case. This will be the first time in our country’s history that this question will be raised.

Who is involved in the THM? It is not one person or group. It is more an awakening by more and more American Citizens to the realization that something is not right with our tax system. The leaders of today’s THM include Aaron Russo, a Hollywood film director and founder of restoretherepublic.com, which is now managed by Gary Franchi from the Lone Lantern Society. Like so many of us, Mr. Russo came to the realization that something was not right in America, and he started to investigate. This culminated in a number of productions, such as Aaron Russo’s Mad as Hell video presentation and the recent America Freedom to Fascism. Aaron Russo has brought more than a message of Tax Honesty, but he has awakened the American public to realize that without personal involvement, by each of us, to hold the government in check, we will continue to lose more and more rights.

Another THM leader is former IRS Special Agent Joseph R. (Joe) Banister. While working at the IRS, Mr. Banister started looking for answers to the questions posed to him by the people he was investigating. After much research and investigation he could not find the answers, so he asked his superiors in the IRS. After he was told basically to shut up and color like everyone else, Joe decided to do something else and to help bring the truth to light.

There are others from the IRS including Sherry Jackson, a former, highly decorated, revenue agent who wanted to answer the questions posed by the “We the People Foundation.” We the People Foundation were offering $50,000 to anyone who could prove the average American was liable to pay taxes. Ms. Jackson wanted to prove them wrong and to collect the $50,000; but she could not find the law, even though she worked for years with the tax code while in the IRS, it just was not there. She now works to help the THM educate the American people.

People like Robert Schulz of the We the People Foundation have spent much of their own time, money, and hard work to bring the truth of individual taxation to all Americans. Mr. Schulz is taking the government to court and is fighting the battle to force our government to be honest with it’s citizens and answer our questions.

Dave Champion is a paralegal and the creator of original intent, a web site dedicated to teaching all Americans the truth about America’s tax scheme. Mr. Champion has spent years studying the tax code, Supreme Court case history, and the Constitution; and has determined that most of us should not be taxpayers subject to the tax code. He also assists people to live within the law as nontaxpayers.

Although that are its primary focus; the THM is about more than just taxes, it is about restoring our republican form of government. THM is about re-instilling transparency and honesty into the dealings between our government and it’s people, it is about re-building trust.

The ideals espoused within the THM also kindle the desire for a return to a government that operates within the bounds set by the Constitution. Today our Constitution is ignored by our Government, unless it suits their needs.

The blame for the corruption of our current governmental system, however, does not lie totally with the government. We the People share the lion’s share of the blame. We have allowed our government to go unchallenged year after year because of ignorance, cowardice, and apathy. Each session of Congress enacts more laws restricting our rights, and we do nothing. Each year the Executive passes more unconstitutional legislation, and we do nothing. Every time the legislature gives up more of its’ responsibilities, we do nothing. It is time the Citizens of this great nation stop doing nothing. The THM are Citizens doing something to help restore accountability within our government.

In my opinion the THM is the last vestige of hope we have to guide this country back to being a Constitutional Republic and a freedom-loving nation. The efforts taking place within the THM and the cases being decided by the Supreme Court to determine if the government has an obligation to respond to the petitions of the people may by the last peaceful means left by the Citizen to hold its’ government accountable. Once a government decides it is not accountable to the people, the people become serfs and are worth no more than chattel; and the only response becomes enforcement by the government.