You’re the subject of an IRS tax audit and want answers. Most pressingly: Why you? To help make sense of it all, we’ve put together this overview on how the IRS chooses audit subjects.
Selection of Returns for Examination
After tax officers complete the initial tax review and correction process, they classify returns for audit potential. Staffers forward possibly incorrect individual tax returns to examination divisions that handle correspondence audits. Questionable business returns are sent to examination divisions.
Fact: The probability of being audited is not affected by file return dates or interaction with the IRS tax line.
Discriminant Function (DIF) System
The IRS identifies returns that warrant auditing by using the Discriminant Function (DIF) System. Computer digitally analyze each return using mathematical formulas. The the tax audit potential of a return is proportional to the DIF score. The higher the score the more likely an audit.
The IRS formerly used the Taxpayer Compliance Measurement Program (TCMP), a random audit selection system that measured and evaluated taxpayer compliance characteristics. The agency used information and figures obtained from the TCMP to determine the DIF. However, the IRS hasn’t used the TCMP since 1987, which it replaced by the National Research Program (NRP).
National Research Program (NRP)
Developers designed the NRP tax audit identification system to accurately measure tax compliance, effectively detect cheating, and minimize the need to make contact during the process. It’s less intrusive and reduces tax audits of taxpayers who filed accurate returns. While the IRS conducts over 700,000 regular tax audits annually, the NRP will extract data from a stratified sample of about 50,000 regular tax audits.
The NRP focuses on measuring three critical areas of tax administration: filing compliance, payment compliance, and reporting compliance. The first area to be addressed is reporting compliance, followed by the two other areas.
Instead of the former practice of engaging in a “line-by-line” tax audit, the IRS will seek to reduce the intrusiveness of the tax audit by using previously collected information. Agents will only ask people selected for tax audit under the NRP about a limited portion of their tax returns. Some taxpayers will not be contacted at all, while others will participate by mail.
The NRP is expected to produce a number of changes, including redesigned forms, improved communications, suggested tax law changes, and enforcement focused on non-compliant taxpayers.
Starting in September 2002, the NRP began working on fewer than 50,000 IRS audits out of 132 million filed returns. The IRS intends to expand the NRP to cover corporate income tax, as well as employment and excise taxes.
Other grounds for selection of return
Agents may also select a return for examination based on information received from third-party documentation, including 1099s and W-2s, that doesn’t match the the relevant return. Moreover, authorities can cull data from public records, informants, and even ex-spouses. Lastly, some parties land in the audit pile simply because the IRS wants to study the behavior of similar taxpayers (a market segment) or a particular tax issue.
Authorities evaluate the information for reliability and accuracy before using it as the basis of a tax audit, examination, or investigation.
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