With tax season now in the rear-view mirror, some taxpayers may be a bit nervous that the returns they filed with the Internal Revenue Service (the “IRS”) will make their way to the audit list. Uneasy taxpayers may find some consolation in the fact that, in federal fiscal year 2015, the odds that an individual will be selected for audit fell to its lowest level in over a decade. The audit coverage rate for individuals, defined as the total number of audits divided by the number of tax returns filed, fell to 0.84%, making 2015 the third consecutive year that an individual’s chances of being audited was less than 1%. With these statistics in mind, you may be wondering, how does one acquire the misfortune of becoming one of the chosen few?
The IRS has experienced recent staffing shortfalls as a result of decreased budget allocations. Revenue agents realize that they have the resources to examine only a small fraction of the total returns filed, and thus seek to examine only those returns that will likely result in a “profitable” audit. To select returns for audit, the IRS uses a number of techniques, including a computer program known as the Discriminant Inventory Function System (“DIF”). The DIF program uses proprietary mathematical formulas to assign a score to each filed return by placing various weights to certain return characteristics. Returns with the highest scores are identified by the computer and then passed along to an agent for a manual review.
So, if your return is flagged by the IRS computer for having a high DIF score, does this foretell the beginning of a horror novel? Not necessarily. If a return has been selected for examination, after a careful review, the agent may choose to “survey” the return rather than proceed to a full audit. A return is surveyed rather than audited if, following an analysis of audit potential, the agent determines that an audit would result in no additional revenue for the IRS.
There is no express guidance as to what constitutes a “survey” of a tax return. A survey appears to be a limited review of available documents with no contact with the taxpayer. Factors that may lead an examining agent to survey a return rather than proceed to a full-blown audit include that a taxpayer is in bankruptcy, the taxpayer has suffered an extreme hardship or illness, the taxpayer is deceased, or the examiner has additional information that was not available during classification. Surveyed returns are accepted as filed. If your return is flagged by the IRS computer and then surveyed by a revenue agent without full examination, you will never know it happened.
In the event that you do become the “lucky” winner of the audit lottery, basic steps can be taken to make the process as painless as possible. Keeping detailed records to substantiate all deductions taken on a return is crucial to ensuring a smooth audit. In addition, engaging your tax professional early in the process can lead to a more favorable outcome. Tax professionals are experienced at working with revenue agents and providing them with the documentation and other information they need to bring an audit to a swift conclusion.
Contact us if you have questions regarding the audit process for individuals and visit the Our Thoughts On blog for more articles on similar topics.
Internal Revenue Manual 22.214.171.124
2015ARD 211-7 (Nov. 4, 2015)
Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.