According to its own enforcement data, the Internal Revenue Service (IRS) “examined” (audited) approximately 1 million federal tax returns in 2018. That figure, though representing only a fraction of the country’s taxpayers, is far from being statistically negligible – and for some taxpayers, such as high net worth individuals, the likelihood of being selected for an audit is much greater than average. But while some audit triggers may be impossible to change or mitigate, such as the amount of income you earn, there are other actions you can take to minimize your risk. In this article, our tax audit attorneys explain how the IRS determines which returns are examined – and discuss some of the steps you can take to help prevent yours from becoming one.
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We initially discussed how the IRS decides which tax returns to audit in 2014. At the time, we noted how certain political groups were at increased risk due to discriminatory targeting – a scandal, now known as the “IRS targeting controversy,” which resulted in multiple resignations (including those of several high-ranking IRS officials). We also touched on some of the IRS’ methods for selecting returns, including its use of computer scoring (which we will elaborate on in this article), procedures for “information matching” (i.e. comparing documents to identify discrepancies), and in later articles, data analytics and even referrals from tax whistleblowers. With 2020 around the corner – and with it, the 2019 tax filing season – our IRS tax attorneys return for another look at the IRS’ audit selection criteria.
These criteria are outlined in IRS Publication 556 (Examination of Returns, Appeal Rights, and Claims for Refund), the guide for which is available here. As its title suggests, this publication covers issues like:
Critically for purposes of this discussion, it also covers, on Pages 2 through 3, “examination selection criteria.” As this section of the publication explains, the IRS uses a program called “Discriminant Inventory Function,” or DIF, which gives each tax return a score based on the information it contains. The IRS uses DIF computer scoring to evaluate all personal and some corporate tax returns, according to Publication 556.
If a tax return receives an unusually high score, it may indicate that there is a problem with the return, which will likely lead to an IRS audit unless the issue is promptly resolved. Unfortunately for the taxpayer who has been chosen for auditing on this basis, examinations of this kind have “high potential” to end with “a change to your income tax liability” – or, in plainer terms, a tax bill from the IRS which will invariably include penalties and interest.
While computer software plays a major role in determining which returns are audited, some of the IRS’ screening methods are less high-tech. For instance, something as simple and as easily detected as a mismatch between your tax return and a 1099 could be sufficient to trigger an audit, depending on the size of the mismatch. While a difference of a few dollars or cents is unlikely to sound major alarms, substantial errors on your tax return, such as material understatements of income, could be cause for a civil or even criminal tax audit – a situation whose classic warning signs are discussed here.
As Publication 556 also cautions, the IRS can obtain information about you from various public sources, such as “newspapers, public records, and individuals.” For example, the California Franchise Tax Board (FTB) is required under state law to publish a top 500 delinquent taxpayer list, as our FTB tax audit lawyers previously discussed here and here. Lists like these are rich sources of information for the IRS – as are the referrals provided by other taxpayers, who can report you to the IRS for suspected tax fraud.
At the Tax Law Office of David W. Klasing, we are IRS tax audit lawyers with more than 20 years of experience providing audit and IRS appeals representation throughout Northern and Southern California. In addition to being an award-winning tax attorney, our founder, David W. Klasing, also has more than a decade of public auditing experience, giving our legal team an incisive, insightful edge whether we are representing individuals or business entities.
If you have been chosen for a tax audit, disagree with the outcome of your audit, or are worried about the possibility of tax evasion charges in connection with an upcoming or ongoing audit, contact our offices right away to schedule a reduced-rate consultation. You can also reach us by calling our main office in Irvine at (800) 681-1295, 24 hours a day, seven days a week.
In addition to our staffed main offices in Irvine, the Tax Law Offices of David W. Klasing has unstaffed (conference room only) satellite offices in Los Angeles, San Bernardino, Santa Barbara, Panorama City, Oxnard, San Diego, Bakersfield, San Jose, San Francisco, Oakland, Carlsbad and Sacramento.
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Will it cost me more to hire the Tax Law Offices of David W. Klasing, who’s main office and the vast majority of the firm’s staff is located in Irvine California, but an appointment only Satellite office is close to my location, as opposed to a local company? Absolutely not! See our policies that address this issue here.