Al “Scarface” Capone and the Financial Status Audit

September 03, 2015 by Eric Linden

What do “Scarface” Capone and a tax audit have to do with each other? Scarface went to prison for tax evasion! Not murder, not racketeering, not gambling. I, personally, would never have guessed that type of charge and conviction for someone with as impressive of a criminal resume. But alas, the vicious gangster was sent to prison for eleven years for - of all things -  a tax crime.

The Federal government must get creative sometimes when attempting to bring down elusive "Dapper Dons" - and Capone was no exception. He was masterful in removing himself from any connection to violence which, as you can imagine, was quite frustrating for the FBI.

But here is where the FBI brought in the IRS - maybe they would be able find something? After all, Mr. Capone was bringing home gobs of money, which the IRS knew. What they wanted to find out was: Is he reporting his income?  And this brings us to the IRS audit topic many are not familiar with: a Financial Status Audit.

A person's standard of living is something that can trigger a tax audit. An auditor could be tipped off about a life of luxury that is not reflected in someone's tax return. The auditor then can use public data to review spending habits and wealth patterns to reveal possible unreported income. Keep in mind that, in 1998, an Act of Congress limited the IRS’s power in this realm stating that they need a “reasonable indication” of probable tax evasion. However, this does seem a bit ambiguous as this statute does not properly define “reasonable indication.”

To get more information, I asked Jean Lee Scherkey from TaxAudit’s Learning and Development team to provide a little insight, and here’s what she said:

“If, after reviewing the taxpayer’s basic tax information, it appears to the IRS the taxpayer does not have enough income to cover living expenses, the IRS examiner is required to delve further. The examiner may conduct various interviews, reconcile books and records and do a complete bank account analysis. If, at this time, the taxpayer is still unable to explain or show how living expenses were paid given the amount of income on the return, the IRS has the authority to use what is called an “Indirect Method” to prove a taxpayer’s true financial status. In fact, one of the five “Formal Indirect Methods” the IRS still uses to assess unreported income were developed when the IRS was investigating Mr. Capone in 1931.”

It's interesting, isn't it? And probably a little bit scary for some people. So there you have it. It is probably best to stay off MTV Cribs if you are not paying your taxes.

We are not purporting that Capone was brought down because of a simple IRS audit. There is much more to this investigation and subsequent conviction, but it does bring up a great illustration on how “living large” can be dangerous for any taxpayer who isn’t reporting all of their income. For example, other famious individuals, such as singer/songwriter Willie Nelson and actor Wesley Snipes, have had serious tax trouble and it, most likely, did not help they were probably not living in an apartment while driving a Hyundai.


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