Three quarters of all returns are selected for audit based upon the return’s computerized DIF score. A DIF score comes from the taxing authority’s often highly secretive computerized rating system, or DIscriminate Function (DIF). Each return undergoes statistical analysis designed to score the return as to its likelihood of material misstatement. A return can be understated because of under reported income or over reported deductions.
The program also identifies returns that do not report correctly information the taxing authority has obtained from third parties concerning your taxable income such as 1099′s, 1098′s and W2′s. The service starts the audit selection process by selecting for audit returns with the worst DIF scores which are 999′s and then proceeds to the 998′s, 997′s and so on until they run out of audit budget. It is this audit selection methodology that led to the expression common to the tax profession of; “Hogs get slaughtered but pigs get fat”.
The other quarter of returns are selected based on information obtained from outside sources that indicates that a return may be understated. These sources of information include newspapers, public records, and whistleblowers. Taxing authorities are known to compare an individual’s perceived standard of living gleamed from these sources of information up against their reported income to determine if a taxpayer’s life style makes economic senses given their reported income level.
Below is a list of factors that add to a taxpayer’s audit potential because of their perceived potential for abuse and the taxing authorities history of success in determining positive audit adjustments to taxable income in these areas:
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