Taxpayers may be tempted to exaggerate the amount of money they earn when submitting credit or mortgage applications so as to qualify for loans or increased credit limits. This could come back to haunt them, however, in an income tax audit.
That is what happened to Carol Trescott, a massage therapist. She was audited, and she did not cooperate with the IRS. So the IRS used the amounts she listed as income on a credit application as income on a return they prepared for her (since she did not prepare a return herself for the tax year). Carol objected, claiming this was not a reasonable basis for computing her income. The Tax Court disagreed, and accepted the IRS return amounts.
In most audit circumstances, the taxpayer will have prepared a return, so the IRS will not be preparing one for them. However, even when there is a return, if the auditor notes a material difference in income reported on the return and what was used by the taxpayer on a credit application, the auditor’s suspicions will be aroused. That is never a good thing to have happen on an audit.
Trescott v. Comm., T.C. Memo 2012-321