With the new year arrives the beginning of another tax season! For some people, with a new year comes an overriding fear that they may be audited by the Internal Revenue Service (IRS). Understanding why a tax return may be selected for an IRS tax audit may give you peace of mind that will abate your fear this tax season.
The IRS tends to use the terms “exam,” “examination,” and “audit” interchangeably. These are all terms used for the process of examining, clarifying, and correcting errors on one or more tax returns. Some people believe that the bean counters at the IRS actually review each tax return received, line-by-line. The IRS does not have the resources to carefully pick through each line of a tax return. Instead, the IRS uses computers to identify certain tax returns with a high probability of containing errors or omissions, and these are some of the selection methods:
- Computer Scoring: The IRS’ Discriminant Function System is a computer program that flags tax returns based on a numeric score. A tax return that has a higher likelihood of problems, such as unreported income, gets a higher score. Then the high-scoring tax returns are then reviewed by the human bean counters, and then selected for audit when warranted.
- Information Matching: IRS computers compare the information on your tax return with the income reports received from third parties, Forms W2 and 1099 for example, and public records on file to quickly identify errors and omissions. If there are discrepancies on your return compared to the reported data, an examination may be the tool used to clear the discrepancy.
- Related Examinations: If you are affiliated with or have done business with people or entities that have been selected for an audit, your chances of also being audited may be higher. This is because when the IRS finds problems with one tax return or transaction, related tax returns or transactions may have similar tax and reporting issues.
- Informants: Some tax returns are selected for an audit based on anonymous tips or are the result of extensive investigation into tax evasion schemes.
- Large Corporations: And finally, some large corporations must submit to routine examinations (often yearly) simply because they generate huge profits and the stakes are too high for the IRS to miss anything.
If your tax return does get selected for a closer look, you should know that the vast majority of audits are completed without ever meeting face-to-face with the IRS. Depending on the issues presented, an examination issue may be resolved with a phone call or a letter of explanation containing the substantiation supporting the position taken on your tax return.
On the other hand of the audit spectrum, however, are the tax audits that cause people to be scared of the IRS. This can mean days, months, or years, of the IRS looking at you and your tax return very closely.
If you are lucky enough to be selected for an audit, whatever the type, the most important advice to follow is that you must respond. Do not ignore the notice, thinking that the government will eventually go away, they will not. For audits, and all tax issues, it is easier to directly address and resolve a tax matter, than it is to repair the damage done by ignoring it.
This article is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.