Understanding IRS Audits: Random or Targeted?

The belief that IRS audits are entirely random is a common misconception. While a small percentage of audits may seem random, the IRS employs a variety of sophisticated methods to identify and select returns that warrant further examination. This article delves into the strategies used by the IRS to conduct audits and identifies the key factors that may trigger an audit.

How IRS Selects for Audits

The IRS uses a combination of methods to select tax returns for audit. These methods include:

1. Random Selection

A small percentage of audits are indeed chosen randomly. This method is part of the IRS's efforts to ensure compliance across the board. However, relying solely on randomness may not be the most effective way to catch those who do not comply with tax laws. As one individual mentioned, their brother was audited due to a second unreported job that increased bank deposits, highlighting that some audits are not truly random.

2. Computer Scoring

The IRS employs a scoring system called the Discriminant Function System (DIF) to analyze tax returns. This system assigns a score based on various factors, such as the extent of deductions compared to income, discrepancies between reported income and third-party information, and unusual patterns compared to similar taxpayers. Returns with higher scores are more likely to be audited.

3. Red Flags

Certain items on a tax return can trigger audits and further examination. These red flags may include:

Large Deductions Compared to Income: Deductions that significantly exceed the amount of income can raise red flags. Income Discrepancies: Reporting discrepancies between income and information from third parties like W-2s or 1099s may prompt an audit. Unusual Patterns: Unusual tax filing patterns compared to similar taxpayers can also trigger audits.

4. Industry Norms

The IRS may target specific industries or sectors that are known for higher rates of non-compliance or fraud. For example, retail, construction, and real estate industries may be audited more frequently due to known vulnerabilities in tax reporting.

5. Prior Audits

Individuals who have been audited in the past and found to have issues may be more likely to be audited again. This practice helps the IRS combat repeat offenders and ensures that those who engage in fraudulent activities are held accountable.

Common Triggers for IRS Audits

Some audits are pulled at random each year, but others have 'red flag' events that are likely to trigger a deeper review or an audit. Here are some common triggers:

Self-employed with all round numbers: While for convenience, using all-round numbers for income and expenses can be risky. Self-employed with very low or no business expenses: Lack of documented business expenses can be a red flag for the IRS. Claiming a step-child as a dependent: Including step-children as dependents without a proper financial relationship can trigger an audit. Educational Credits with no 1099 Form: Lack of appropriate documentation for educational credits can prompt further examination.

Additionally, any discrepancies in property tax payments or verification of business expenses can also lead to an audit. The IRS relies on these factors to ensure that taxpayers are filing accurately and honestly, thereby maintaining tax compliance.

Conclusion

While some IRS audits may appear random, the IRS uses a variety of methods to identify and target returns that warrant further examination. Understanding these methods can help taxpayers anticipate potential issues and take steps to proactively comply with tax regulations.

By staying informed about the various triggers for IRS audits and implementing sound tax practices, individuals and businesses can minimize the risk of being audited and ensure their financial health and compliance.