IRS audits process are often a random selection. However, there are some triggers that can set the audit wheels in motion and bring on further examination and the possibility of paying more to the tax man. An MSN article titled: “What triggers an IRS audit?“ shines some light on how the IRS selects returns for audit and the criteria that sets these returns apart from the rest.
Audits on the Rise
The Great Recession forced the government to help struggling taxpayers address their tax debt issues. As a result, the IRS has expanded its Fresh Start Initiative to help more struggling taxpayers qualify for Installment Agreements, the Offer in Compromise Program and has increased the tax lien thresholds to offer some tax relief. At the same time, the IRS was facing pressure from Congress to step up collection efforts to help fill in budget gaps.
So while there was an increase in IRS tax relief for some, others, most notably wealthy Americans, were finding themselves under audit. The IRS examined roughly 1% of all individual income tax returns in fiscal year 2012. Individual tax returns that reported higher adjusted gross incomes were more likely to be examined. (This previous post provides more IRS Data Book information on the subject). Other factors can trigger a closer look and additional examination:
- First-time homebuyer credit
- Small-businesses such as a partnership or a Schedule C filer reporting self-employment income on your personal tax return.
- Earned Income Tax Credit (EITC) for lower income taxpayers that may eligible face added scrutiny. According the MSN article, IRS data shows that it audited 2.1% of returns by filers reporting less than $25,000 in income and who claimed this tax credit.
The IRS Scoring System: Discriminant Information Function (DIF)
According to MSN, the IRS states there are several ways a return can be selected for audit. The first one is via the Agency’s computer-scoring system known as Discriminant Information Function, or DIF. tax returns are based on IRS formulas, and DIF is based on deductions, credits and exemptions with norms for taxpayers in each of the income brackets. But the “audit formula” is a well-kept secret. Some tax experts believe one discriminant information function component looks at average deduction amounts allowing IRS examiners to spot inconsistencies, such as a high mortgage interest deduction and low income.
The MSN article highlights information gathered by Tax specialists at CCH who examined 2010 return statistics and came up with these itemized deduction averages. These numbers are only informational only and meant to give a general idea as to whether certain tax deductions might seem out of line. According to the article, here are some examples of what is likely to trigger a DIF red flag:
- Higher incomes.
- Income other than basic wages; for example, contract payments.
- Unreported income, such as investment returns.
- Home-based businesses, especially when in addition to salary income, and home-office deductions.
- Noncash charitable deductions.
- Large business meal and entertainment deductions.
- Excessive business auto usage.
- Losses from an activity that could be viewed as a hobby rather than a business.
- Large casualty losses.
Low-income wage earners claiming the Earned Income tax Credit (EIC) can trigger an audit by making legitimate mistakes on a return, but also for making false claims. Also, Schedule C business losses can catch the eye of the IRS.
Taking the “trigger” tax credit or deduction
The article reminds readers that you should take all the legitimate tax credits and deductions you are entitled to. Rule of thumb: In all cases, you will want to have excellent records to back up your claims in case you are questioned. If all is legitimate, you have little to worry about.
Hire a tax audit professional to help
Due to the increased IRS collection activities, it’s in your best interest to prevent an IRS audit at all costs. If you are past the point of prevention and owe back taxes there is a solution to your problem, but you need to act now. Even if you can’t afford to pay your back taxes, a Certified Tax Resolution Specialist, IRS tax attorney or CPA, can help you negotiate and IRS payment plan that can settle your IRS debt for good.
More Tax Help, IRS News and Tax Relief Tips:
- Tax Relief FAQ: What Is An IRS Installment Agreement for Payment of Back Taxes?
- New Changes to Offer in Compromise – More Flexibility
- Tax Resolution Services-The Week in Tax Relief News