Why are Tax Returns Selected by the IRS to be Audited?

There are many different reasons why a tax return may be selected for audit by the IRS. The reasons why some returns get picked for examination are actually heavily guarded secrets.

What types of tax returns are audited by the IRS?

That being said, sole proprietorships are subject to much higher audit rates than so-called “wage & investment” returns and business returns (corporations and partnerships). The IRS gets more bang for their buck when auditing a proprietorship (income tax + self-employment tax). Also, when a person is audited and there are significant adjustments made, the IRS will typically come back and examine the taxpayer again for a later year.

 

IRS Audit Selection

Every processed return is assigned a score, called the Discriminant Function (DiF) based on the facts and amounts claimed as income, deductions, and credits. The DiF score may lead to selection based on the likelihood that an examination would result in a tax assessment.

 

IRS Audit Selection Factors

It’s less about who prepares your return, and more about what is being claimed. Certain returns are selected upon receipt, again based on the claims made on the return. One major factor in this type of selection is the Earned Income Tax Credit, which is a significant refundable credit that increases when qualifying children are claimed. In some cases, the IRS requires taxpayers to produce and prove every item on their return including such things as their children’s Social Security numbers.

 

How does the IRS Select Tax Returns for Audits

Selecting a return for audit does not always suggest that an error has been made. Returns are selected using a variety of methods, including:

  • Random selection and computer screening – sometimes returns are selected based solely on a statistical formula.
  • Document matching – when payor records, such as Forms W-2 or Form 1099, don’t match the information reported.
  • Related examinations – returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.

 

How many tax returns are audited each year?

Short on personnel and funding, the IRS audited only slightly less than 1% (0.96%) of all individual tax returns in 2013. An IRS audit is a review/examination of an organization’s or individual’s accounts and financial information to ensure information is being reported correctly, according to the tax laws, to verify the amount of tax reported is accurate. If you made less than $200,000, your chance of being audited was just 0.88 percent. That’s down from the 0.94 percent audit rate in fiscal year 2012.

 

IRS Audit Advice

General IRS audit advice: read everything sent to you carefully & follow any instructions given, including requests for information. If you get your records organized, the audit goes much smoother.

Publication 556, Examination of Returns, Appeal Rights and Claims for Refund explains the audit process in more detail.

Frequently asked questions are also available.