Are my chances of an IRS audit greater than they were in the past?

Although the Internal Revenue Service (IRS) has increased the number of IRS audits in the past decade, most taxpayers do not need to worry about being selected for a tax audit. The IRS spends most of its time and resources pursuing very high income taxpayers and corporations. Taxpayers who earn less than $100,000 need not worry as long as they are honest and file their tax returns on time. The IRS selects tax returns for tax audit by using a computer program called the Discriminant Inventory Function (DIF) system. The DIF system gives each tax return a numerical score. Nearly all tax returns that receive a high DIF score are audited because the IRS believes that there is a good chance that after auditing high DIF score tax returns, there will most likely be a change in the amount of tax owed by the taxpayer.

While the IRS is not very clear on what exactly goes into calculating DIF scores, we do know that the DIF system compares your tax return to tax returns of other taxpayers in your income bracket. Assume Mary reports an income of $50,000 on her tax return, but then also claims charitable donation deductions totalling $10,000. Mary will most likely to receive a high DIF score because it is unusual for taxpayers in her income bracket to donate 20% of their income. Also, the DIF system also compares how much income you report and how much income others in your neighborhood report on their tax returns. For example, if you live in an affluent area where the average income of the taxpayers is $200,000 a year and you report an income of $30,000, it will also cause you to receive a high DIF score and be more likely to be the subject of an IRS audit.

Certain taxpayers are at greater risk for tax audit based on the nature of their job or source of income. The IRS is suspicious of self-employed taxpayers because many deduct personal expenses by labeling them business expenses on their tax returns. Other taxpayers such as waiters and those who work in the gaming industry are also at a high risk for an IRS audit because they earn mostly in cash. Most recently, the IRS has been on alert for taxpayers that might be involved in committing financial fraud. Taxpayers who use offshore credit cards, have very high incomes, investors in abusive schemes, and those with fail to include certain sources of income are also at risk for being audited because the IRS is carefully monitoring their activities.

Case Studies: Scenarios of Examining IRS Audit Chances

Case Study 1: Mary’s Charitable Donations

Mary, a taxpayer with an income of $50,000, claims charitable donation deductions totaling $10,000 on her tax return. This unusual deduction in relation to her income bracket may result in a high DIF score, potentially increasing her chances of being audited.

Case Study 2: Income Disparity in Affluent Neighborhood

John resides in an affluent neighborhood where the average income is $200,000. However, he reports an income of only $30,000 on his tax return. This significant income disparity compared to others in his neighborhood might lead to a high DIF score and a higher likelihood of an IRS audit.

Case Study 3: Self-Employed Taxpayers and Personal Expenses

Self-employed individuals are often under scrutiny by the IRS. Taxpayers who label personal expenses as business expenses on their tax returns raise suspicion, increasing the chances of an audit.

Case Study 4: Cash-Earning Professions

Professions that predominantly deal in cash, such as waiters or those in the gaming industry, have a higher risk of being audited due to the difficulty in accurately reporting cash income.

Case Study 5: Red Flags for Financial Fraud

Taxpayers involved in certain activities, such as using offshore credit cards, having high incomes, participating in abusive schemes, or omitting specific sources of income, are closely monitored by the IRS and face an elevated risk of audit.