How Tax Returns are Selected for Audit

by Al Gutkin

THERE ARE TWO CATAGORIES OF AUDITS

1. Personal tax return audits - done at the IRS office.

2. Business Audits - done at the taxpayers place of business or the accountants office, if the taxpayer chooses.

PERSONAL TAX AUDITS

Personal tax returns can be selected for audit by three different methods. I will discuss these methods first as there is a second process the tax return goes through before you are notified of an audit.

The first method is the DIF score method (see paragraph below on DIF score). Every personal tax return is given a DIF score when it is processed through the IRS computer. The higher the score, the more chance of an audit.

Several months after the return is filed the District Director, of your residential area, makes up a budget of available manpower to perform audits. This includes the number of audits he expects his district to accomplish during the next year. Based upon the budget, the IRS computer automatically selects from the highest DIF scores down until enough return have been selected to to satisfy the budget requirements of the district.

The second method comes from the Adjustment Section of the computer center. This is the mistake section. If you make a mistake in addition or completion of your tax form the computer can't process it without Human help. Thus, your return gets passed over to the Adjustment section for correction. If they can't figure out your mistake, It's referred for Audit.

The third method is The Special Project Method. Also a computer method of selection. If the IRS determines that there is tax abuse in a specialized area, the computer searches the data base for deductions in that particular area and bango, the whole lot is audited. This method can also be used for certain types of occupations, such as doctors, tax preparers etc. Example... The IRS passed laws regarding Offices in the Home and Personal Computers. If the IRS determined that in 1985 most tax payers didn't heed the rules (proper way of listing the deduction) or failed to segregate the computer from other items listed on form 4562. There will be a project to audit tax returns for which there is an (assumed) incorrect business deduction.

DEFINITION OF DIFF SCORE.

Every five years the IRS runs a program called TCMP ( taxpayer compliance measurement program). The purpose of this program is to monitor the results of taxpayer audits. This type of audit is very much in-depth. As the agent must fill out an extensive questionaire concerning each audit and the results. The computer audit division compiles the results of the agent's reports with an eye for areas of non-compliance with the tax laws (big adjustments). The IRS computers are then programmed to evaluate returns filed in subsequent years based upon the this criteria. Thus the diff score of three digits is assigned to every return as it is processed through the IRS computer. The higher the score the more likelihood of an audit.

WHAT HAPPENS NEXT. AFTER YOUR RETURN IS SELECTED.

After your return is selected for audit, by any of the methods above, a real live Human Being looks at it. Agents usually volunteer for this duty.

The agent has no idea why the return was selected, this is kept a secret. He or She then has to look over the returns and select three items to be examined. The computer may have given the return a high score because of one item, however, the agent must select three. Hence, some taxpayers are are asked to prove areas of deduction that are small or obviously correct. In addition, if you, the taxpayer, included a lengthy expanation of a deduction as part of your tax return package, it will arouse the agents attention and this item will be selected for review. In other words, lengthy explanations should not be attached to your tax return. The only time it would be looked is after your return was selected for audit by the computer.

HOW ARE BUSINESS RETURNS SELECTED FOR AUDIT?

The process of selecting business returns, such as corporations and partnerships, is completely different from individual returns. It is much simpler and more human as opposed to the computer selection of individual returns.

Business returns are selected completely by hand, no computer. Field agents (business auditors) volunteer to work on a temp. detail at the service center for the purpose of selecting business returns to be audited. There are no set guidelines for the selection process and a business return can be selected solely based upon that particular agents whim. I have heard of agents seclecting returns for audit because they had to many staples in them. The returns selected for business audit do not have specific areas indicated for audit, the examining agent at the local level makes the selection while on the business site.

We are now at the conclusion of the selection process performed at the regional service center. The next step is for the selected personal and business returns to be transferred from the service center to the local examining office.

WHAT HAPPENS AT THE LOCAL EXAMINING OFFICE?

The personal returns to be audited are assigned to "Office Audit" and the appointment clerk sends out the notices to the taxpayer. The notices indicate which items are selected for audit and the substantiation needed. The taxpayer has ten days to make an appointment for the audit.

Office audit agents do not have very much latitude when it comes to whether or not the selected items are valid areas of audit. If the item is listed to be audited, by god, the agent will audit that area no matter how insignificant that particular item may be.

Business auditors, are a different breed altogether. Most have had extensive training in accounting and tax, which is a required before they are even hired. A business agent has complete latitude in selecting what items are to be audited. The agent can also look at the return and decide not to audit it. The business is not contacted when the return arrives at the local office, they are contacted when and if the local agent is ready to start the audit. I have also heard that some agents actually don't audit returns because the tax consequence is to small or the business location is undesirable. Again, I have aalso heard the the same agent will select more items on the business return because there are to many staples or the return is sloppy. No kidding!!

CONCLUSION --- MAKE YOUR OWN

Like it or not, this is the system of audit selection in the United States. There are two ways to approach it. One is to bitch, bitch, bitch and get nowhere. The other is to become knowledgeable of the system and figure how to deal with it from a position of strength and knowledge.

If you choose the second approach, I will be following up this educational masterpiece with several more in the future.