How Does The IRS Select Tax Returns For Audit?

What types of audit red flags does the IRS use to select returns for audit?  Under its “National Research Program” the IRS first comes up with a “baseline”, or theoretically acceptable, return for different types of taxpayer profiles.  The IRS uses special software to select returns that vary significantly from this profile.  This “DIFF” (Discriminate Function System) software assigns each return a “DIFF Score”.

The Service changes its algorithm from time to time.  While the IRS does not release the particulars of this process, it is common for taxpayers to learn what are the common “red flags” based on the types of audits people start seeing in the field.

From there an IRS auditor conducts an initial assessment of the computer-selected returns. The auditor determines whether to accept the return as-is or to select the return for audit.  If the IRS selects your return for audit you will receive a notice to this effect.

Can you avoid IRS audit red flags?  Yes and no.  Keeping your tax reporting consistent year over year will help.  We believe that large increases or decreases in income may affect your DIFF score.  Now, this hardly means you did anything “wrong”.  It simply identifies your return as one which may merit more attention.  Income that attracts attention is better than less that goes unnoticed.  Your industry also may affect whether the IRS selects your return for audit.  At present, real estate professionals (adding insult to injury perhaps) are being targeted for audit by the IRS.

You can get IRS tax help.  An important thing to remember is you have the right to be represented if your return is selected for audit, and you should.  There are both strategic and practical nuances to the audit process.  There is, as they say, a time and season for different approaches.  Sometimes cooperation is in order, sometimes it’s necessary to fight back.  A lot depends on the issue and the auditor.

Contact me for an overview of the tax audit process and what you might expect if your return is selected for audit.