Does the IRS Check Your Bank Account?

Can the IRS access your bank account?

In the past, they didn’t unless the taxpayer was being audited. However, due to policy changes during the Biden administration, the IRS now has access to bank records without having to notify the taxpayer.

The IRS already has access to most third-party accounts, such as Social Security accounts, previous income tax returns, and information submitted via W-2s and 1099s. Technically, they know how much most people make.

Banks, for their part, have always been required to report various transactions to the IRS, including any interest paid on investment accounts or payments received through a payment processor. As of 2021, they must also report total deposits and total withdrawals for the year.

When large deposits or cash come in and out of the account that doesn’t reflect reported income, the account owner will likely get audited.

Wage and salary earners and recipients of federal benefits are exempt from financial reporting.

Why Does the IRS Want to Look at My Bank Account?

The ultimate goal of this exercise is to narrow the tax gap.

What’s the tax gap, you say? It’s the $600 billion difference between taxes owed and taxes collected.

The United States Department of Treasury estimates that America’s wealthiest citizens successfully avoid paying more than $160 billion annually, which is undoubtedly a major catalyst for the administrative push.

The U.S. Department of the Treasury states that their primary motivation for the financial reporting proposal is to reduce audits of compliant taxpayers and to get high-earning tax evaders to pay their share. In theory, that sounds nice. But there is a darker side.

What Does the IRS Want to Know?

The IRS is not concerned with individual transactions, and the bank is not required to disclose that data. They are looking for a disparity between your cash flow and the income you reported on your return.

If there is a huge between what’s on your return and what the bank reports, buckle up.

The auditor will want to establish whether the unreported funds were income or not—and they might well not be.

Sometimes, the answer is simple and easily substantiated. You might have transferred funds from another account or line of credit, gotten a loan or a gift or received non-income funds for another reason. If that’s the case, it can feel like a massive invasion of privacy and can end up being a costly process if you’re not prepared.

All the IRS wants to know is if you should be paying tax on the unreported amount, and it’s your job to substantiate where the money came from.

If your financial records are organized and your books are clean, the case may be closed quickly. If not, it can open the doors for audits of previous years’ returns and generally cause a lot of headaches for you.

Can I Prevent the IRS From Looking at My Accounts?

In a word, no. Banks must report total deposits and total withdrawals, plus interest and other income-related account activity.

A recent Supreme Court ruling found that the IRS does not have to notify account holders even when they issue summonses for a taxpayer’s bank records. They are also not required to inform third parties who might be part of the investigation that their bank records are under scrutiny.

Such was the case in Polselli v. Internal Revenue Service, where an individual under investigation had transferred money to his wife and a law firm, both of whom were summarily swept up in the information collection processes preceding the audit.

The plaintiffs were not informed of the summonses by the IRS. The bank notified them, and they filed to have the order quashed. The suit was unsuccessful due to some specific exceptions that allow the IRS to proceed without serving notice.

What that means is if you happen to have transacted substantially with an individual or entity under investigation for tax evasion, the IRS may be able to access your bank account without your knowledge. Innocent though you may be, there is not a lot you can do about it.

Preparation is Your Best Defense Against the IRS

Invasive inquiries aside, your best defense against the IRS is to keep your finances on the up and up. Working with a CPA can help as they have the experience and knowledge to identify potential red flags. With proper documentation, you’ll be able to substantiate your transactions and stave off any further scrutiny easily.

If you have serious discrepancies between your bank account and your return, you might be unable to avoid an audit. The best way to mitigate the damage is to be prepared.

In most cases, audits are conducted through correspondence. The auditor will request specific information, and it’s your job to provide it. If the information they request is readily available, you can look forward to a quick wrap-up.

Additional information can also be helpful to back up your submissions. Keep all gas receipts, calendar entries, mileage logs, and any other documents that might add weight to the expense or non-income deposit.

Working With Prep Tax Smart to Mitigate IRS Scrutiny

You can’t avoid paying taxes. But you can prepare yourself for a potential audit and shield your customers and family from stealthy IRS scrutiny. Prep Tax Smart has the tax planning expertise you need to get in front of potential issues before they become big problems.

Our CPAs understand the challenges small business owners face today. We work closely with our clients to provide services and advice tailored to your unique needs, helping you build a sustainable business and achieve financial peace of mind.

Book a call today, and let’s talk about how we can work together to build a long-term tax strategy that advances your business goals.