Q: What are the most common IRS audit red flags?
A: The IRS is clearly on the lookout for scofflaws these days, and with an enforcement budget a record $5.5 billion, it has the money to be scrupulous. The IRS will only take the time to audit returns it believes will result in additional tax to be collected. It takes less than you might think for them to "red flag," or mark for additional scrutiny, a particular tax return. Some of the most common items that continue to catch the IRS's eye are the following: The DIF score is the most widely used method for selecting tax returns for IRS tax audit. There are also other methods to select tax returns for IRS audit. Since DIF score is used often by the IRS raising IRS audit flags, we shall discuss how DIF score works to gain an understanding of the DIF score system.
What is a DIF score?
DIF score or the discriminate function system is the name the IRS calls the computer generated score the IRS uses to select tax returns to undergo IRS audits. The majority of audited income tax returns are selected by means of DIF score.
How is DIF score generated?
The DIF scores are generated by IRS computers. DIF score is a statistical profile that is computed by comparing the tax numbers (income, expenses, and deductions) on income tax returns with numbers generated using national statistics for tax payers in a similar income tax bracket.
Computing DIF score
The real formula of how to compute DIF score is not revealed by the IRS. However, contributing factors to computing DIF score can be found on tax payers' tax returns. An example of item on tax return used to compute DIF score is a loss on a sole proprietorship business (found on schedule C of the tax return). If these numbers or expenses are out of line with the numbers shown on DIF analysis, then the chances of an IRS audit increase. DIF score and DIF analysis is one of many factors the IRS uses to determine if an IRS audit is necessary.
1) Failure to report income. Remember that the IRS receives copies of all of the W-2s and 1099s and other income reports that you receive. Inadvertent failure to report income is still failure to report income.
2) Claiming false business expenses. Consider under this heading excessive home office deductions, claiming 100 percent of a vehicle for business, and lavish trips with only the most tangential business reason. The IRS is hip to all of it. Strong, organized documentation can get you through the audit, but prepare to be audited if you are claiming big expenses in proportion to earnings.
3) An incomplete or mathematically sloppy return, or no return filed at all. If the IRS has to spend time sorting out a return, or a return is filed late with no tax paid, it will likely take a very close look.
4) Excessive charitable donations without formal documentation. Make sure you have receipts or acknowledgement letters from the charities that specifically state the amount you have donated to back up your claims.
5) Home-Buyer Credit Claim. The IRS is screening all claims for this credit, many due to the fact that first-time homebuyers and longtime homeowners have historically not attached the proper documentation to the return. Make sure your documents are in order.
6) Unreported foreign accounts. There are obvious big problems if you are trying to evade taxes by stashing income in offshore accounts that the IRS uncovers, but there can be inadvertence or incompleteness in reporting by consumers or executives who maintain overseas accounts for business reasons.
If you do get audited, do not even think about going it alone. Just as you would not go to court without a lawyer, so you should not attend an audit without a Certified Tax Resolution Specialist.
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