LET’S now discuss the last of three articles: How the IRS scores tax returns for audit. The higher the score, the more likelihood that you’ll be chosen for audit.
1. Scoring System: The IRS uses a Discriminant Function System (DIF) to determine returns that are most likely to generate additional revenue for the government. Although the scoring is secret, it’s based on two factors: Total Positive Income and Total Gross Receipts. A return with a high DIF score is more likely to be audited, since such a score indicates a greater probability that additional revenue will be generated. The DIF score is based on statistical profiles developed through the National Research Program (NRP).
2. National Research Program (NRP) The IRS developed a new NRP to replace the old Taxpayer Compliance Measurement Program (TCMP). NRP developed new audit criteria from a stratified sample of approximately 50,000 individual audits. Data obtained from the NRP audits are being used to score returns for audit.
3. Exceeding National Averages Attract Audits: Taking deductions that exceed national averages increases your audit score. TIP: If you exceed the averages, opt out of e-file. Instead, paper file and attach explanation of unusual amounts such as big donations or large medical bills.
4. Other Sources of Audits: Audits also come from matching programs, return preparer programs, claims for refund, or separate related-party audits.
5. Employment Tax Audits: The main goal is to secure statistically valid information for determining the most noncompliant employment tax areas (home care industry for example). The IRS selected 2,000 taxpayers each year for the last three years to focus on worker classification issues—independent contractors versus employees (1099 versus W2).
6. Nation’s Tax Gap: The IRS estimated the nation’s annual gross tax gap (meaning the difference between what taxpayers should pay and what they actually pay) at $450 billion 10 years ago. The Treasury Inspector General for Tax Administration (TIGTA) indicated that the tax gap is even wider since the IRS formulas are outdated and unable to include much of the underground economy (workers paid under the table and purchases paid by cash).
7. Tax Gap – Statistics Show That:
A. Failure to report income accounts for 80% of the total gap.
B. Nonfiling and underpayment account for 10% each.
C. More than 80% of individual underreporting comes from understated income.
D. Most of understated income comes from business activities.
E. Individual income tax is the largest source of the gap, accounting for 60% of the total gap.
F. Underreporting is lowest where there is third-party reporting or withholding (W2 and 1099).
8. Future Audits: The IRS Commissioner and the Treasury Inspector General for Tax Administration (TIGTA) have indicated that closing the tax gap has become a higher priority with increased document matching programs, expanded information reporting programs, examination of high income individuals and Schedule C’s with a history of losses. All these factors lead to more IRS audits in the coming years.
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Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in Pasadena, California.
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He has 50 years of experience in defending taxpayers audited by the IRS, FTB, EDD, BOE and other governmental agencies. He is publishing a book on his expertise – “HOW TO AVOID OR SURVIVE IRS AUDITS.” Our readers may inquire about the book or email tax questions at [email protected].