How Does the IRS Pick Tax Returns to Audit?

January 28, 2010 by Jim

s never fun. Even if you ignore how you must spend a couple hours filling out boring forms, finding documents, researching deductions, blah blah, there’s always the fear that you’ll be audited. I remember having the most vanilla tax returns back when I was a teenager, the 1040-EZ, and even then I was irrationally concerned about an audit.

The reality is that very few people get audited, just a couple percent each year, and some of them deserve it. As much as we may like to think of the IRS as some cruel, emotionless monster trying to make the lives of hardworking Americans as miserable as possible, they’re not. They’re trying to collect tax revenue so the government can continue to provide the services hardworking Americans need.

So how do they decide who to audit? It’s actually very straightforward.

In 2006, they published a page on the IRS.gov website that details exactly how they determined which tax returns to audit. It comes down to these four main ways (for individuals):

  • Computer Scoring – I listed this one first because it’s the most interesting of the four reasons. Tax returns are “scored” using two systems – Discriminant Function System (DIF) and Unreported Income DIF (UIDIF). The Discriminant Information Function System (DIF) score gives the IRS an indication of the potential for change in tax due, based on past IRS experience. The Unreported Income DIF (UIDIF), as you can imagine, scores the return on the potential for unreported income. The higher the score, for either, the more likely the return will be reviewed.
  • Information Matching – This is an obvious reason because it’s the easiest to catch. The IRS receives the same W-2s and 1099s that you do, so it’s trivial for them to compare the two totals. If they don’t match, they investigate.
  • Related Examinations – Beware who your friends/business contacts are! If their returns are audited and their return includes transactions with you, your return may be audited as well.
  • Potential participants in abusive tax avoidance transactions – The IRS may get information about promoters of and participants in various schemes and select a return for audit based on that information.

Most of the red flags you read about fall into one of the first two categories. For example, if you under report your income, you could trigger both the UIDIF score and the information matching reasons. If you participate in an abusive tax avoidance transaction and the guy who plans it gets caught… you’ll probably get audited. :)

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