Question

Colleen Matthews had just turned 22 when her hard work finally started to pay off. Six months earlier, Colleen had graduated from a state university with a master's degree in accounting. Colleen graduated with honors and was one of the youngest in her class. Unlike most of the intellectuals she had studied with throughout her career, Colleen was extremely social and had great communication skills. After graduation, she took a job with a well-known regional accounting firm. The firm specialized in assisting companies with their technology problems. Colleen knew that the connections and knowledge she would gain working for the firm would be beneficial throughout her career. Now, six months after graduation, she has a full-time job offer with one of the firm's strongest clients. Within a few days on her new job, Colleen had adapted to her new environment. Colleen and two other recent graduates were vever, it wasn't long until Colleen began to notice that something wasn't right. After a few weeks, Colleen realized that the firm's executives were participating in illegal transactions. The company executives were importing expensive technological products from China and selling them under the table to contacts unknown to Colleen. Once the firm received the products at the shipping dock, the executives' "personal employees" marked the products and took them to a separate location. The entire operation was done with little paperwork. The money received from the special products received special attention. Colleen was told to report this inflow of cash in an account called "Personal Executive Consulting Services. This allowed the executives to personally use the money at their convenience. 1. Does Colleen have a responsibility to report the apparent fraud? 2. If so, to whom should she report the fraud? 3. Assuming that the fraud has been continuing for several years, what would be the tax ramifications to the executives of not reporting earnings on their tax returns? 4. Even though the money is from illegal sources, are the executives required to report the income on their annual tax returns? 5. Earlier in the book, we discussed the net worth method. How do you think the net worth method can help prosecutors determine the extent of these executives illegal income?

Answer 1

1 Colleen has the responsibility to report the fraud. Colleen is an employee of the company and is handling the accounts department. She is responsible that accounts are properly maintained and books report true and fair view of the transactions. Any fraud which comes to her knowledge, she has to report it. She is responsible to the company, to the management and to the shareholders as well. Thus, such fraud should be reported by Colleen. 2 The fraud needs to be reported to immediate reporting authority. However, if executives themselves are involved she can report it to management directly. Also, there is a policy called Whistle-Blower where all such activities can be reported. She can also inform the Auditors of the company who are then liable to report it in their audit reports to the management and shareholders. She can also write a letter to management to inform the shareholders about such fraud. 3 Any income earned by a person needs to be reported in tax returns where they become taxable. If such fraud has been continuing for several years and not been reported then income for all past years becomes taxable. The persons will be liable for penalties for under reporting of income and in extreme cases they might also be liable for criminal charges. If under reporting is due to negligence, then criminal charges are not will not be initiated. However in this case, it is negligent and hence will be liable for interest, penalties as well as criminal charges for non-reporting of income. 4 Be it legal or illegal source, income needs to be reported in income tax returns. As per held by courts, any income that is eanred is to be reported in returns and illegal income is laos to be reported. Expenses incurred for earning such income are also allowed as deduction. Thus, executives need to report the income in annual tax returns. 5 Net Worth method means assets minus liabilities. The total assets that executives have and total liabilities both need to be netted off and balance will be taxable. The total income that should have been reported but not reported needs to be calculated and total liabilities for such income needs to be know. The balance of the two will be taxable. In such way, net worth method can be used for the purpose of calculation.