How you enter the cage of tax audit

IRS selects around 1.5 million taxpayers in a year and ‘invites’ those to explain inconsistencies in their tax return.  How does it select these taxpayers out of 135 million returns filed every year?  Well most of the times it applies some criteria to pick a ‘deserving’ taxpayer.  Here are some important ones.

1. Mathematical corrections – Usually IRS computers generate these audits. If you have made mistakes while filing your tax return, these computers are most likely to catch you.  These are silly mathematical mistakes which you would have avoided easily.  Some of these mistakes are - entering incorrect spelling of your name on your tax return, entering incorrect social security number, entering the incorrect status, making a wrong calculations about earned income credit and improper assessment of estimated tax.

Usually IRS assumes that your details are correct and makes the calculation of your tax figures based on them.  If there is any additional tax liability, they will add interest and penalties to it and you will be sent a notice demanding such money.

You will have a period of 30 days to contact IRS and schedule an appointment to prove that your original data is correct.

2. Mismatching of documents – These audits are also computer generated.  All the forms you file along with your tax return like W-2 forms or K-2 forms will be cross checked with the details sent by the issuer of such forms.  If IRS comes to a conclusion that you did not report all your income on the basis of this cross verification, they can send you a bill specifying the extra amount including interest as well as penalties to be paid by you.

When you receive such notice, you get 30 days to clarify your position.

3. DIF score – This is a secret formula developed by IRS which identifies the returns most eligible for tax audit.  If the DIF score on the tax return is higher, IRS will decide to audit such tax return.  The reasons which trigger increase in DIF score are many like Schedule C expenses, drastic changes in your income or unusually high deductions.

4. Random selection – IRS selects randomly individual returns for audit purposes.  These returns will be scrutinized very minutely.  The auditor will go line by line to examine the whole of your tax return and will ask you to provide enough supporting evidence. These are most dangerous audits and nobody can predict which returns will be selected in a particular year.

5. Public records and statistics – Focusing on the standard of living of a taxpayer, based on public records and statistics available, the auditors will try to establish that you have unreported income.  Public records may include credit reports, property records, motor vehicle records and reports on currency transactions.

6.Special projects – IRS will pick a dozen scams every year and intensify scrutiny of all concerned people.  These ‘dirty dozen’ will face all sorts of scrutiny and will be handled by a special division of IRS.

While IRS will naturally concentrate on unscrupulous people not reporting their correct income, it is possible for an ordinary taxpayer to avoid most of the above nets with a disciplined and honest approach.