As a former IRS agent the number one question I am asked is, “why does IRS audit a tax return.” Its Your DIF Score. Understand the process, save off a IRS Tax Audit.

While there are variety of reasons the IRS audit tax returns, the chief reason is because of the DIF score. That stands for, Discriminate Index Function.

Every return filed goes through an numerical DIF audit and every return is rated,ranked, and scored by the IRS.

The DIF process is responsible for more IRS tax audits than any other of the IRS processes.



Each year more filters are added and it process becomes more deadly and brings a greater ROI.



So what is the” DIF ? ”, Discriminate Index Function


It is a mathematical technique used to classify income and expenses on tax returns as to successful IRS tax audit potential.

Under this concept, formulas are developed based on available data and are programmed into the computer to classify returns by assigning weights to certain basic return characteristics.

These weights are added together to obtain a composite score for each return processed. This score is used to rank the returns in numerical sequence (highest to lowest).

The higher the score, the higher the probability of significant tax change.

The highest scored returns are made available to IRS audit agent and eyeballed so see what tax returns have the greatest audit potential and bring to the field.

IRS has mandates on how many tax returns they audit based on examinations guidelines from the National office and expected revenue, so it only make sense the IRS plans to attack the low-hanging fruit.


What IRS says about the DIF Score
 
Its a computer scoring IRS audit.

Some returns are selected for examination on the basis of computer scoring. Computer programs give each return numeric “scores”.

The Discriminant Function System (DIF) score rates the potential for change, based on past IRS experience with similar returns.

The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported income.

IRS personnel screen the highest-scoring returns, selecting some for audit and identifying the items on these returns that are most likely to need review.


More good info on the DIF Score.

The program takes into consideration your:

1.income,

2.the size of your family,

3.where you live, zip code,

4.how your money is earned,

5. expenses taken,

6. tax credit,

7, business income compered to business losses,

8.and key line items on your tax return.

There are about 22 filters IRS uses.

IRS has an algorithm it runs all returns through to see if a tax return has audit potential.



Your DIF score is far from the norm, BINGO, you win the nasty gram from the IRS.


If you know that your return has what we refer to as “red flags,” you need to be extraordinarily careful to keep accurate records and receipts.

Another interest of note, just because your tax return has a high DIF score does not necessarily mean that your tax return will be audited.

A human auditor will look at the return to confirm that this tax return has audit the potential.

IRS Audit Information

A key component in promoting the highest degree of voluntary compliance on the part of taxpayers is enforcement of the tax law. By pursuing those individuals and businesses who don’t comply with their tax obligations, the IRS is being fair to those who are compliant.

This helps promote public confidence in our tax system for all taxpayers.

The IRS enforces the tax law in a number of ways. The primary way is through the examination of tax returns that are identified as having the highest potential noncompliance.

This identification is determined using risk-based scoring mechanisms, data driven algorithms, third party information, whistle blowers and information provided by the taxpayer. The objective of an examination is to determine if income, expenses and credits are being reported accurately.

Types of IRS Tax Audit Examinations

IRS employees conduct examinations or audits in one of two ways. The first is by mail and are called correspondence examinations.

The second, called face-to-face examinations, take place in person at an IRS office or at the taxpayer’s place of business.

The complexity of the return determines whether the audit is by correspondence or in person. Certain individual non-business returns with low and medium adjusted gross income can be handled effectively by correspondence audit.

All other returns selected for examination are better handled either as an in-IRS office examination or at the taxpayer’s place of business.

IRS Tax Audit Correspondence Examinations

Correspondence examinations are performed at IRS campus locations by tax examiners, who are GS-5, 6, 7, or 8.

The IRS currently employs 969 tax examiners conducting correspondence examinations of simple individual Form 1040 returns. Generally, the questionable issues are EITC, additional child tax credit, American opportunity tax credit, medical expenses, contributions, taxes, or employee business expenses.

Tax examiners receive training on these issues but are not required to have accounting skills.

An additional 144 tax examiners conduct correspondence examinations of non-resident alien returns (Form 1040NR) focusing generally on withholding.
Correspondence examinations are less burdensome for taxpayers than in-person audits as they mail in their documentation and don’t have to travel in or take a day off from work to visit an IRS office.

They are also the most efficient use of IRS’ examination resources with a correspondence examination costs the IRS approximately $150. In FY 2018, the IRS conducted 75% of examinations by correspondence.

IRS Face-to-Face Examinations

Tax Compliance Officers (TCOs), who are GS-7, 9, and 11, conduct face-to-face examinations in IRS offices (sometimes called an “office audit”). The IRS currently employs 572 TCOs. TCOs receive more training than tax examiners and have some accounting training.

An audit by a TCO generally requires an in-office interview of the taxpayer but doesn’t require an on-site inspection of the taxpayer’s books, records, or assets.

The types of issues selected for an office audit are income from tips, pensions, annuities, rents, fellowships, scholarships, royalties, and income not subject to withholding; deductions for business related expenses; deductions for bad debts; determinations of basis of property; capital gain versus ordinary income determinations; and complex miscellaneous itemized deductions such as casualty and theft losses.

The most complex returns, which are certain individual, corporate, and partnership returns, are audited by a Revenue Agent (RA) at the taxpayer’s place of business. Revenue Agents are our most highly trained and experienced employees with substantial accounting skills and are GS-9, 11, 12, 13, and 14.

The IRS currently employs 6,463 RAs.

Their skills are required due to the complex business transactions of the taxpayer, more voluminous records, and extensive time required to complete the audit. In addition, the issues involved in a RA audit may require assistance from a specialist, such as an engineer, economist, or appraiser.

Since these are the most costly examinations conducted by the IRS, RAs are directed to the most egregious noncompliance areas.

These include high income, high wealth taxpayers, cash intensive businesses, transfer pricing, executive compensation, research and development credits, crypto currencies, as well as others.

BIG TIME KEY TAX TIP

If you’re submitting a tax return that you believe has red flags, attach the documentation to the return so when the auditor is looking at the return to score, the information is attached to shield off the audit.

Example:

A great example of this is if you tithe to a church and that tithe is well above the norm, actually enclose the statement and the check so when the auditor is looking at the tax return he can nix the tax audit.