The Internal Revenue Service (IRS) audits only a small percentage of tax returns each year. However, the process behind selecting those returns is based on several factors. Understanding how the IRS chooses which returns to audit can help taxpayers avoid unnecessary scrutiny.
· The IRS Audit Process
The IRS has a specific system for selecting tax returns to audit. They do not randomly pick returns. Instead, they rely on a combination of technology, data, and analysis. By using specific methods, the IRS ensures they focus on returns with the highest likelihood of discrepancies or errors.
Some returns are selected through the IRS’s automated systems, while others come under review through more detailed analysis.
· Discriminant Function System (DIF)
One of the key tools the IRS uses is the Discriminant Function System (DIF). This system compares tax returns to a set of norms based on similar returns. If a return significantly deviates from these norms, it receives a higher DIF score.
Returns with a high DIF score are more likely to be audited. The system focuses on identifying irregularities, such as unreported income or unusually high deductions, that could indicate errors or fraudulent activity.
· Random Audits
Although rare, the IRS does conduct random audits. In these cases, the tax return is selected as part of a statistical sample. These audits help the IRS assess compliance across a broad range of taxpayers.
Random audits are not triggered by any particular red flag or error on the return. Instead, they are a way for the IRS to maintain oversight of the tax system as a whole.
· Targeted Areas for Audits
The IRS also focuses on specific areas known for higher rates of tax fraud or errors. For instance, taxpayers with significant self-employment income may be more likely to face an audit. This is because self-employed individuals are more prone to mistakes in reporting income or deductions.
Inaccurate reporting on business expenses and charitable contributions can also lead to audits. Working with a tax audit attorney is recommended when handling complex financial matters to ensure accuracy and reduce audit risks.
· Red Flags That May Trigger an Audit
Certain actions or patterns on a tax return are more likely to raise red flags with the IRS. For example, reporting large losses, particularly from a side business, could attract attention. Inconsistent income reporting or excessive deductions beyond typical ranges may also result in closer inspection.
Taxpayers who earn over $200,000 annually are statistically more likely to be audited. This is because higher income levels often involve more complex returns, making them prone to errors. Consulting with an EDD tax attorney can help ensure tax filings are accurate and minimize potential audit risks.
· Related Party Transactions and Offshore Accounts
Related party transactions, such as income or deductions involving family members or affiliated companies, are also more likely to be scrutinized by the IRS. Similarly, taxpayers with offshore accounts or foreign assets often face stricter audit standards due to the complexities involved.
Those with foreign income or accounts should ensure that they comply with all reporting requirements. Failure to report such accounts correctly can lead to an audit and potential penalties.
· How to Handle an Audit?
If the IRS selects a return for an audit, taxpayers should respond promptly. The audit process can be stressful, but timely communication helps resolve issues efficiently. In many cases, the IRS may only request additional documentation to clarify items on the return.
Working with an IRS audit attorney in Los Angeles can make the audit process more manageable. These legal professionals help taxpayers provide the necessary information and resolve disputes that arise during the audit.
Conclusion
The IRS relies on systems like DIF, random selection, and targeted reviews to choose returns for audits. High DIF scores, red flags, and patterns of inconsistency increase the likelihood of being audited. Taking precautions and seeking professional advice ensures that tax returns are accurate, reducing audit risks.