how did the IRS or any other revenue agency audit dozens of millions of paper tax returns every year before computers were common?

Question

How did they verify if someone committed fraud or tax evasion in the 1950s for example?

In: 19

Answer 1

I had a family member go through an audit in the 90s. What the guy did was show up at his office, sit at a desk and request and go through financial records to make things tie out. Could you give fake documents (which would be a major crime)? Sure, but the way accounting works is that all inflows and outflows are recorded on a general ledger which rolls into trial balances which then become financial statements. So as they look through your financial statements and tax returns, etc., it should all tie back to a general ledger, which should then be further supported by evidence like invoices, credit card processing statements, bank statements, things like that. So let’s say I recorded a bunch of erroneous expenses to try and reduce my taxable income. An auditor should be able to try that back through the general ledger to see what those expenses were, and then match those to the bank statements and accounts payable systems to see what the actual invoices for those were. If stuff doesn’t match or make sense, then that’s where you dig in. And as someone else said, they learn to have a general sense of how things should be and dig in on things that don’t look right. In one example I’ve heard, a construction company was recording like $75k per year (this was in the 90s) on “Training and Education.” Now, you’d expect some cost there for workers getting certifications, but 75k for a company of that size was insane. So the IRS looks into what was in there. Turns out it was the owner expensing his kids’ college tuition to reduce taxable income. That’s a no-no, and I think he got fined for that.

Another thing the agent would do is start conversations with employees. He would always start like general chit-chat kind of stuff, and by asking questions would gradually steer the conversation towards mining them for information which would assist in the audit.

As someone else said, you submit returns every year but they don’t audit all returns every year. Even today with computers, a full audit is an intensive process.