Few things are more unnerving than having your tax return
selected for an IRS audit. The IRS uses that "audit anxiety" to help keep
taxpayers honest on their tax returns.
 DIF Scores Count
The IRS evaluates tax returns based on their "DIF" scores, a set of
IRS formulas known as the "Discriminate Function System." About three-quarters
of all returns audited are selected by the DIF computer, which compares deductions,
credits, and exemptions with the norms for taxpayers in each income bracket.
While these formulas are kept very secret by the IRS, you can count on having a higher
audit probability if you fall into certain categories or report certain things on your tax
return.
What
Interests the IRS?
Some higher risk areas are -
1. Tax protests. Both the IRS and tax courts
are getting fed up with what they consider frivolous tax protests. If you file a return
stating that you owe no tax because the dollar is worthless or make some other such
protest, you'll probably be audited.
2. High income. Because auditing
higher-income taxpayers is likely to produce more additional tax revenue than auditing
lower-income taxpayers, this category is targeted by the IRS.
3. Certain occupations. Taxpayers whose
occupations produce cash income, such as taxi drivers and waiters, run a higher risk of
being audited. Self-employed individuals, particularly independent contractors, are IRS
targets for the same reason; they are more likely to have unreported cash income.
4. No preparer or a problem preparer. If you
have a complex return and prepared it yourself, or if your return was prepared by someone
on the IRS's problem-preparer list, you are more likely to be audited.
5. Certain deductions. The IRS has found it
profitable to audit returns that claim office-in-the-home deductions, travel and
entertainment deductions, and certain other write-offs where they feel taxpayers stretch
the truth.
6. Related party transactions. Taxpayers who
involve family members in their financial operations are more likely to be scrutinized by
the IRS. Paying wages to your children, lending money to relatives, splitting income among
family members, or running a family business will make the IRS more interested in your
returns.
Your
Best Audit Defense
Between one and two percent of all individual tax returns filed in any year will be
selected for audit.
Unless there is suspicion of fraud or substantial understatement of income, the IRS has
three years from the due date of your return to initiate an audit. Typically, most returns
are selected within two years of their filing date.
The best defense in an audit is a two-part strategy:
- Have supporting documentation for all deductions and credits.
- See your accountant immediately upon notification that you're being audited.
A professional can put your mind at ease, find the information that the IRS wants more
quickly than you can, and very likely will save you money in the long run by getting a
faster and more favorable conclusion to the audit.
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