Indirect Methods of Proof
When taxpayers don’t file returns—or when the IRS believes income is missing—they don’t always need your records to figure out what you earned. Instead, the IRS uses indirect methods of proof to estimate your income. Understanding these methods helps you know what to expect if the IRS challenges your filings.
What Are Indirect Methods?
Indirect methods are ways the IRS reconstructs income when direct records (like W-2s, 1099s, or books) aren’t available. These methods rely on lifestyle, spending, and bank activity to show whether reported income matches reality.
Common Methods Used
Bank Deposit Analysis
IRS totals deposits across your accounts and assumes they’re income unless you prove otherwise (loans, transfers, gifts, etc.).
Expenditures Method
If your spending exceeds reported income, the IRS assumes unreported income made up the difference.
Net Worth Method
IRS compares your net worth at the beginning and end of the year. A large increase not explained by reported income may be treated as taxable.
Unit and Volume Methods
Often used in businesses (like restaurants or bars). IRS estimates sales by multiplying the number of items sold by their price.
Why It Matters
Indirect methods can be aggressive. The IRS isn’t required to prove every dollar—just that your lifestyle and accounts don’t match your reported income. The burden shifts to you to explain the difference.
Protecting Yourself
Keep personal and business accounts separate.
Retain documentation for non-income deposits (loans, gifts, transfers).
Work with a professional if the IRS starts an indirect proof review.
Indirect methods give the IRS powerful tools to prove income even without traditional records. Knowing how they work helps you prepare, defend yourself, and avoid being taxed on money that isn’t really income.
If the IRS is questioning your income, don’t wait. We can help review the methods they’re using and make sure you aren’t paying more than you owe.