It is rare that tax fraud investigators or special agents are called upon to reconstruct a complete set of financial books and records to determine whether a tax crime has occurred. More commonly the analysis of existing financial records is the investigative technique employed. Such searches of business books and records are undertaken in an attempt to link financial transactions to criminal activity. The “paper trail” followed when reviewing accounting books and records is sometimes long and winding, but ultimately culminates with a logical conclusion. Unfortunately for the tax cheat, the results are oftentimes those employing deceit and deception.
Informants (anonymous or otherwise), whistleblowers, tax squealers, including ex-spouses, former employees and others frequently point tax fraud investigators in a specific direction. Although their portrayals may facilitate the process, the needle in the haystack must still be discovered to enable a successful prosecution. Sometimes it may be less sophisticated or more ordinary than others. However, allegations by themselves will not sustain a charge of income tax evasion (U.S.C. Title 26, Section 7201). Hence, the skills and expertise of the specially trained financial investigators begin the dissection of available financial records with surgical precision.
The analysis of accounting books and records is referred to as auditing. The process of auditing is comprised of three parts; analyzing, scrutinizing and comparing. These are key elements fraud investigators employ when searching, tracing and dissecting financial transactions contained within accompanying books and records.
Analyzing – The accounting books and records are divided into their basic components. What this means is that entries in the journals, etc. are each individually analyzed to determine whether or not they were appropriately charged to the correct account. In other words, have basic accounting principles been followed? If not, why not?
Scrutinizing – This is the process of matching documentation, or lack thereof to each transaction. Are there any unusual notes or remarks that do not conform to ordinary business practices and procedures? Was there a business reason for the transaction? Does back-up documentation exist?
Comparing – This involves evaluation and comparison of the source documents through independent corroboration, outside of the business itself. In other words, are the invoices in fact legitimate? Are the figures appearing on invoices and bills accurate? This is a search for inconsistencies or any transactions that appear to be out of the ordinary.
Adjusting entries are frequently utilized to conceal illegal activities in an effort to balance business books. For example, the owner of a trucking company was diverting funds from his business for his personal use. The financial investigator was examining the books and identified a substantial amount of truck washing expense within the general ledger. Upon further analysis and review, it was determined that the excessive truck washing expenses were being paid to a shell company, controlled by the owner of the trucking business.