During tax season, a dreaded nightmare is an audit by the Internal Revenue Service (IRS). Many taxpayers fear that a slight miscalculation on a tax return may trigger an audit when the facts show that a very small percentage of filers are investigated.
To some taxpayers, the IRS is to police officers as tax evasion is to crime.
When an audit is underway, it feel like a self-invitation by the government to poke around in every corner of your finances with microscopic detail. But, for the majority of tax return filers, the chance of an audit is rather slim.
Audits Are Uncommon
In 2010, the IRS processed 142,823,105 individual tax returns and 1,581,394 of those returns were audited, which represents roughly 1.11% of the total individual tax returns filed. Statistics on 2009 tax returns from the IRS showed that millionaires were on the receiving end of audits at an increasing rate.
Those numbers may come as a relief to the average taxpayer who often loses sleep worrying whether that extra deduction would alert the IRS. The IRS affirms that an audit notice in the mail doesn’t always mean that an individual made an error or is allegedly a tax cheat. “In fact, some examinations result in a refund to the taxpayer or acceptance of the return without change.”
The IRS Audit Selection Process
For individuals, there are four general ways that the IRS may choose your tax return to audit:
- Potential participants in abusive avoidance transactions. The IRS will select some tax returns based on information obtained by investigations of promoters and participants of abusive tax avoidance transactions.
- Computer Scoring. Some tax returns are audited based on formula that gives scores each tax return. The Discriminant Function System (DIF) score evaluates a return’s potential for change, which is based on past IRS experience with similar returns. The Unreported Income DIF (UIDIF) score evaluates a return for the potential of unreported income. IRS employees will review the returns with the highest scores and some are audited.
- Information Matching. All forms and income documents furnished to the IRS and matched to the information on tax returns. Some returns are reviewed when there are discrepancies between income reported and the documents that the IRS received.
- Related Examinations. If a return is associated with another taxpayer whose returns were audited, that return may be audited as well. Examples include connections with business partners and investors who’ve been audited.
The IRS does not disclose the computer scoring model or the DIF or UIDIF scores to filers. Reported information that doesn’t match documents sent to the IRS can render a questionable DIF and UIDIF scores.
There is a higher chance that you’ll be audited if you have relations with other people or situations involving an audit or tax evasion.
Good record-keeping is essential when it comes to avoiding an IRS audit. Also, you’d be under scrutiny if your income reaches seven figures.