Tax Audits: How Being Audited Works

Arm yourself with knowledge about tax audits and how being audited works so you can avoid an audit in the future.

| March/April 1985

  • Tax Audit
    Your likelihood of being audited is relatively small, but it'll be even smaller if you take the precautions outlined in this article.

  • Tax Audit

Getting Audited: How You Get Picked

Each year the IRS selects about 2 percent of all returns to be audited — a process they now prefer to call examination. The majority of the returns are picked by computer according to a technique called discriminant function (DIF), which is based on criteria updated periodically with information produced from about 50,000 thorough audits under the Tax Compliance Measurement Program (TCMP). The forms to be audited for TCMP are picked randomly by social security number, so anyone could be picked for a TCMP audit. The majority of audits, however, are selected at the National Computer Center in Martinsburg, W.V., from the DIF list of items — the contents of which are a closely guarded secret.

We do know that the DIF system divides returns into 10 taxpayer categories, so that the data from TCMP can be applied selectively and boundaries for deductions can be set up. If one or more of your deductions exceeds the amount DIF has decided is appropriate for your category of taxpayer, the computer tallies points for your return. Other flags may be included, such as tax assessment changes made in previous audits. Should the total points you score be above the threshold for your category, your return will be flagged for audit.

Once flagged, the information is sent to the IRS district office in your area, where an experienced agent classifies all selected returns according to audit priority. Some may be disqualified from audit, but none may be added. In general, the returns with the highest possibility of producing large tax assessments are given greatest priority. Obviously enough, audits that have proven lucrative in previous years are likely to be repeated. Those with lower priority may not be audited, simply because the IRS hasn't the staff to get that far down the list.

Other returns may be selected for audit at the district office for a variety of reasons. For example, returns prepared by "notorious" tax professionals — the IRS has a program to identify such persons — are often selected. This is also the place where audits can be initiated by people reporting others for suspected evasion. The IRS encourages this program by offering anonymity and rewards of up to 10 percent of the additional tax assessed. Furthermore, district auditors may decide to examine your return because they've found irregularities on a return of someone with whom you have business dealings. For example, if one person's claim reveals a problem with a real estate partnership, then every partner will probably be audited.

Returns may also be selected for audit at the regional service center, where they are screened for such things as mathematical errors, unallowable deductions, improper head-of-household claim, multiple filing, federal-state cooperation and agreement with information returns. The IRS now matches up close to 90 percent of information returns to 1040's. Large cash transactions must be reported: The IRS has caught a number of people who bought houses with cash from unreported sources.

How to Avoid Getting Audited

As we've already mentioned, the methods by which the IRS picks returns for auditing are very secretive, but there are a number of approaches that can lessen your chance of being audited — all of which could be summed up under "keeping a low profile."

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