How and why the IRS Selects Tax Returns for Audits

Did you know that:
  • The IRS audits a total of 1,391,581 tax returns a year.
  • The IRS field agents complete more than 310,000 audits by office or business visits a year.
  • The IRS completes over 1,081,152 correspondence audits a year.
IRS Policy Statement P-4-21 it states "The primary objective in selecting returns for examination is to promote the highest degree of voluntary compliance on the part of taxpayers".

The examination plan

The plan that is used by the IRS is based on long range coverage planning, and objectives on the resources requested in the Congressional Budget. From this, there is an established plan where staff years are allocated to all area IRS offices using resource allocation and a prescribed methodology. Each Area Manager of the IRS are responsible for preparing an area response following instructions from the National Headquarters.

Staffing for the IRS audit

Staffing for each office is based on the examination priorities that differ from office to office and region to region, front loaded programs set up before hand, historic examination rates adjusted to yield sure ended results and audits that match experience of the personnel.

Front loaded programs

Front Loaded programs are those audits that headquarters has determined are very important and a considerable amount of time must be spent on these programs and activities.Each area has discussions within management what the programs should be for each region, district, and office. Some of the programs are
  • Special enforcement programs - An example of this may be compliance of all flee market vendors. A program I was involved with
  • High Income non-filers - IRS would get their information a match program of w-2's and 1099's and match up social security numbers against filed returns
  • Abusive Tax Avoidance - This could be in the area of offshore activities
  • Offshore credit card program
  • National Research programs - Those set forth by management after doing a trends project.
IRS makes sure there is balanced coverage The National Office makes sure there is a balance approach for audit return delivery and tax compliance. Resources and inventory and the size of personnel all go into this formula. The focus is blended into these areas:
  1. Individual returns less than $100,000.
  2. Individual returns greater than $100,000 but less than $200,000.
  3. Individual returns greater than $ 200,000.
  4. Small Business Corporations.
  5. Small Business Flow-Through Entities - S Corporations, Fiduciaries and Partnerships.

Classification Plan

IRS will prepare a plan, which is classified. A National DIF score indicator is placed on all Federal Income tax returns that are filed. Each return has certain factors that contribute to its score such as Gross Income, Adjusted Gross Income and line item expense. There are several classified secrets that go into the DIF score. A ratable ordering tool and guide are also available on the Exam Planning and Delivery Web site, .http://sbse.web.irs.gov/epd/

Minimum DIF Cutoff Score

  1. (Discriminant Function) is a mathematical technique used to score income tax returns as to examination potential. These formulas were developed based on available National data. Each return measured under DIF receives a DIF score. Generally, the higher the score, the greater the audit potential. The highest scored returns are made available to Examination upon request.
  2. DIF mathematical formulas are confidential and for official use only. The DIF score assigned to a return should not be disclosed.
  3. Each year, National Headquarters Examination establishes a National SB/SE DIF cutoff score for returns added to the DIF inventory. Returns with a DIF score higher than the minimum are added to the DIF inventory and may be ordered for classification.

DIF Cutoff Score

The IRS will calculate the Area DIF cutoff score for each activity code, giving consideration to the selection rate. This is the lowest DIF score necessary to secure the number of returns required for audit. For example, if the return plan shows 225 returns for an activity code and the selection rate is 70%, the IRS will need to order 321 returns (225/70%). The DIF Cut off Score is 500. The number of returns with DIF scores greater than 550 is 280, which is less than the number of returns required, so the lowest DIF score on an ordered return will be in the range of 500 to 550 and the DIF cutoff score is 500. This is the IRS example as found in the IRS IRM section 4.

Where your case is worked

Examination inventory is assigned to the Area IRS offices based on ZIP codes using the Look up Tables at Martinsburg Computing Center.

High Assault Risk Areas

Certain ZIP code areas are identified as High Assault Risk Areas . There are special insturcutions IRS has regarding these audits. These returns will be audited.

Survey of Examination Cases

IRS can look over your case and close the case with an eyeball look 1. While cases should be selected and started in accordance with these all guidelines, in a "limited number of circumstances" there may be returns that appear in the"judgment of the examiner and manager" to warrant survey without taxpayer contact.That is to not even contact the taxpayer. 2. Cases delivered to the IRS area manager will generally fall into one of three categories: mandatory work, strategic (priority program) work, and non-strategic work. A. Mandatory work includes nationally-coordinated research projects such as NRP and employee audits (excludes "new" IRS employee audits) B. Strategic work is identified annually in the Exam Program Letter which can be found at http://sbse.web.irs.gov/Exam/ . The procedures to survey strategic work and referrals from other business units, "new" employee audits and cases with previous taxpayer contact require an explanation for the rationale for the survey. C. Cases that are not mandatory work, strategic work, a referral from another business unit, and are not part of an employee examination or research study may be surveyed based upon the professional judgment of the examiner with concurrence of the immediate supervisor. 3. Here are some factors to consider when determining whether to survey strategic work: A. Taxpayer is in bankruptcy B. Taxpayer has suffered an extreme hardship or illness C. Taxpayer is deceased, or D. Examiner has additional information that was not available during classification. E. This is in the complete judgment of the IRS tax auditor. From year to year IRS changes there programs to keep everyone honest. However after years of experience, a trained eye can know what tax returns will be pulled for audit.