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May 28, 2019

De-Mystifying the IRS Audit Selection Process

IRS Audit Selection

Those who tempt fate might cling to the well-known maxim that “everyone” cheats on their taxes. In NASCAR there are plenty of notable quotes about the prevalence of cheating in the sport that are analogous (if not humorous):

  • There are two types of racers—cheaters and losers. - Smokey Yunick
  • If you don't cheat, you look like an idiot; if you cheat and don't get caught, you look like a hero; if you cheat and get caught, you look like a dope. - Darrell Waltrip
  • I don't particularly tell my guys to cheat. I just tell them not to get caught. - Richard Petty
  • If you ain't trying to cheat a little, you ain't likely to win much. - Richard Petty
  • If you ain't cheatin', you ain't tryin'. - Unknown

The sentiment that tax cheating is prevalent may rely on a notion that the cheaters never get caught, because few returns are selected for audit. For instance, about 0.6% of all individual tax returns were audited in 2018 – less than 1%. In total, the IRS audited a comparable 0.5% of all returns filed by any type of taxpayer during that timeframe. These statistics give rise to the term “audit roulette,” which refers to the seemingly random—and low—chance of getting audited. But these sentiments rely on fundamental misconceptions about the audit selection process and a lack of understanding regarding the other enforcement tools available to the IRS. And not to mention, these sentiments are illegal, after all.

It is true that very few returns get audited and that the number of returns subject to audit is dropping, and while some of that drop is a result of IRS budget cuts, the audit percentage does not tell the whole story. To fill in the gaps, it is important to understand how tax returns are selected for audit.

Your DIF Score and Other IRS Audit Techniques

One of the chief ways is through automated computer programs. Nearly every return submitted to the IRS is analyzed by a computer program to search for indicators that the return may not be wholly accurate. Under this program, each return is assigned a score, commonly referred to as a DIF score.

The actual calculation of the DIF score is closely guarded to prevent an incentive for impropriety. If a taxpayer’s DIF score indicates that there is a potential issue, the return is then reviewed by a revenue agent or tax compliance officer who then makes the decision on whether to refer the return to an audit office. Returns are then prioritized and assigned to auditors. Some returns may also be screened out at this point.

The DIF score is not the only tool at the disposal of the IRS. Returns may also be selected for audit via a referral from another government agency, or they may be identified during an audit of a related taxpayer. For example, an examination of a taxpayer’s business return may trigger a related audit of their personal return.

In some cases, the IRS focuses on certain areas of noncompliance. These initiatives are usually called campaigns and are typically announced by the IRS in advance. In addition to the DIF score, computer programs also look for data mismatches. This can be as simple as a discrepancy between reported income and W-2 forms, or may include an analysis of credit card transactions in the case of a business return.

The key theme among all of these methods is that they are far from random, and the DIF score analysis and the data mismatch analysis are performed on nearly every return. This renders the “audit roulette” terminology misleading at best.

Non-Audit Methodologies

Audits are not the only IRS tool available to remedy errors or omissions in a tax return. One may commit errors or omit income from a tax return, and may get a bill from the IRS even though the tax return is not audited. This is because, in addition to audits, the IRS will send taxpayers notices informing them of potential issues with their return, without performing a full audit.

Most of these notices are issued under a program called the Automated UnderReporter (AUR) Program. Notices issued by the AUR Program state the nature of the issue and whether an additional payment or refund is due. As the number of audits has declined, the number of these AUR notices has sharply increased. In fact, an IRS audit of the AUR program in 2015 revealed that 20 million individual tax returns had been identified by the AUR Program since 2009. This is a much larger number of returns that were selected for audit during this timeframe. The rise of AUR notices is attributable to the data matching programs previously discussed. In many cases, the data mismatch is sufficient grounds for the IRS to propose an assessment without the need for an audit.

Take Away

Taxpayers have options to manage an audit or an AUR notice, though these options can be time consuming and often require assistance from a skilled tax professional. With the modern tools available to the IRS to root out inadvertent errors and outright cheating, opinions about the tax compliance system should not be gleaned from the audit rate percentage alone. For more information on the IRS examination process or assistance with an IRS collection or audit issue, please contact your local CBIZ tax professional.

2019 Business Tax Planning Supplement

Copyright © 2019, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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