The Contractor Who Never Had a Bad Year
Marilyn Cho is the sole shareholder of a staffing company and filed a 2023 Form 1040 reporting adjusted gross income of $95,000. She kept no general ledger; her preparer used summaries Cho provided. A criminal investigation develops these balances. On January 1, 2023, Cho's assets were residence equity of $140,000, brokerage accounts of $60,000, retirement accounts of $80,000, and vehicles of $40,000; she had no liabilities. On December 31, 2023, her assets were residence equity of $155,000, brokerage accounts of $190,000, retirement accounts of $95,000, vehicles of $75,000, a boat worth $120,000, and $180,000 cash in a safe deposit box; she had no liabilities. The agent estimates personal living expenses at $140,000 for the year. Cho received $50,000 in gifts from her parents and a $25,000 inheritance, both nontaxable. Bank records show no loans or other nontaxable sources. Cho says the safe deposit box cash came from years of saving.
1. Compute Cho's unreported income using the net worth method. Show the formula, each adjustment, and explain how the safe deposit box affects the computation.
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Net worth at the beginning of 2023 was $140,000 + $60,000 + $80,000 + $40,000 = $320,000. Net worth at the end was $155,000 + $190,000 + $95,000 + $75,000 + $120,000 + $180,000 = $815,000. The increase in net worth is $495,000. Under the net worth method, add personal living expenses of $140,000, because those expenditures reduced net worth but were paid from income: $495,000 + $140,000 = $635,000. Subtract known nontaxable receipts of $75,000 ($50,000 gifts + $25,000 inheritance): $635,000 - $75,000 = $560,000. That figure represents reconstructed AGI. Reported AGI was $95,000, so unreported income is $465,000. The $180,000 safe deposit box is the critical issue. If the cash existed on January 1, 2023, the opening net worth is understated and the increase is overstated; if it was accumulated during 2023 from unreported income, it is properly included. The agent cannot simply assume either version. The government must establish the opening net worth with reasonable certainty and negate the cash-hoard explanation, or the $465,000 figure is vulnerable.
2. Identify the three weakest assumptions in the net worth computation and describe the evidence you would obtain to address each one.
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First, the opening net worth is the weakest link. The agent should obtain prior-year bank statements, brokerage statements, tax returns, property records, and loan applications to verify the January 1 balances. A loan application may list assets the agent missed. Second, the cash-hoard claim must be tested. Ask Cho for specific dates, amounts, and sources; check prior banking patterns, safe deposit box rental records, and whether she made large cash purchases before 2023. If she consistently spent her reported income, a large preexisting hoard is less credible. Third, the personal living expenses estimate of $140,000 should be corroborated with credit card statements, mortgage payments, utilities, school tuition, travel, and insurance records. Also verify asset values, especially the boat and residence equity, and confirm that the gifts and inheritance were actually received and deposited. Finally, investigate whether any accounts were held jointly or for others, and whether there were tax-exempt receipts. Each alternative source must be traced; otherwise the reconstruction overstates income.
3. Cho's attorney argues that the net worth method is unconstitutional because it forces Cho to prove her innocence. How should the agent and prosecutor respond?
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The net worth method is an investigative and evidentiary technique, not a presumption that shifts the burden of proof. The government bears the burden of proving the defendant's opening net worth with reasonable certainty, the increase in net worth, and the absence of reasonable nontaxable sources. The leading cases require corroboration of the net worth computation and require the government to negate reasonable leads supplied by the defense. If the government proves those elements, the jury may infer that the increase came from taxable income. The defense is free to offer evidence of a cash hoard, gifts, loans, or prior accumulations, but the government must investigate those claims rather than ignore them. The agent should document every alternative source considered and every attempt to verify Cho's explanation. The argument that the method is unconstitutional is therefore overstated; the real vulnerability is an incomplete opening net worth or an unnegated cash hoard, not the legal theory itself.