As a former IRS agent I am asked this question more than any other question,”why was I audited by the IRS.”
I could write pages upon pages and the different IRS audit techniques but the number one way that you are audited is because of the DIF score.
IRS has four major programs and pulling taxpayers for audits.
But the DIF stands alone as being the number one technique used by Internal Revenue Service because it is most accurate in finding tax dollars and inaccurate tax returns.
IRS run studies and figures on ROI or return on investment.
The two programs that standalone for return on investment for IRS are:
1. the matching programs were the IRS matches W-2s and 1099s against tax returns, and,
2. the DIF score.
How The DIF Score Triggers the Dreaded IRS Tax Audit
Each tax return is issued a DIF Score (Discriminatory Index Function).
According to the IRS, a DIF Score “is a mathematical technique used to score income tax returns for examination potential.”
This technique establishes the National Average Guidelines.
Generally, if a DIF score is above the national average, then the risk of an audit escalates. The highest scoring tax returns are then forwarded to an IRS Examiner for further review.
So what triggers a high DIF Score?
Falling out of the National Average Guidelines in the areas of Charitable Contributions, Casualty Losses, Home Office, and Travel & Entertainment will affect the tax return’s DIF Score. basically, any time you can take a deduction an exemption or a tax credit those are areas that are scrutinized by IRS because it simply has the ability to lower your taxable income. So any expense item of any kind is put into the DIF calculator.
Other audit triggers are unfiled tax returns and failure to file the FBAR (Foreign Bank and Financial Account) Form. ”
How DIF Actually Works
To arrive at the DIF score for each tax return, the IRS computer identifies returns by assigning weights and certain basic tax return characteristics. These weights are added together to obtain a systemic composite score for all tax returns. That score is used to rank all returns into numerical sequence.
There are a series of algorithms set up by Internal Revenue Service that compare income, to expense ratios and other factors that IRS keeps undertake guard.these percentage ratios that IRS enters into the system is guarded like the formula for Coca-Cola. but really at the end of the day it’s quite simple, does your tax return make sense. It’s easy to spot a return that’s being pulled from an audit by Internal Revenue Service.
The highest scores are then manually reviewed by IRS Agents at the Service Centers to determine the merit and worthiness of a Tax Audit.
Since each return is manually reviewed, if you have an unusually high deduction, attach a copy of the bill, receipt and an explanation to the return. Those extra steps will probably prevent that tax return from the dreaded IRS Tax Audit.”
The number of audits performed annually is also determined by the IRS Annual Budget and Agent availability, region by region. According to the 2019 Proposed Budget, the IRS has increased appropriations again to increase resources for the Enforcement Division. This includes investigations, examinations and collections.
If are an in need of assistance for an upcoming IRS audit, please contact the Tax Resolution Specialists at Fresh Start Tax LLC.
Fresh Start Tax is a professional tax resolution firm.
On staff are Board Certified Tax Attorneys, CPAs, and Former IRS Agents, Managers and Instructors. We have over 206 years of professional tax experience and over 60 years of direct IRS experience.
To learn more about Fresh Start Tax, LLC, please visit http://freshstarttax.com or call us at (866)700-1040.
IRS Tax Audit Defense – Protect Yourself
How to Protect Yourself From An IRS Audit
1. Have your tax return prepared by a reliable tax return preparer. If your preparer promises large refunds without asking to see the proper records for deductions and credits, you know that you will be audited after the return has been filed.
When your tax return preparer deducts items that should have not been deducted, you’re the one who will be audited and you will be required to pay the additional tax, interest and penalties.
If the IRS believes that your tax return preparer is incompetent or deducts large non-existent deductions, all of the returns prepared by that return preparer will more likely be selected for audit.
You do not want a tax return preparer who promises you the largest refund, but a tax return preparer who will compute the correct tax. It is recommended that you hire a tax return preparer who knows the tax law and who deducts items on the tax return that you can properly document.
Don’t forget you are ultimately responsible for the additional tax, interest and penalties.
2. File all your required tax returns by the due date. If you haven’t filed your tax returns, the IRS will eventually audit on you.
By not filing your tax returns timely, the IRS will assess the failure to file penalty at 5% per month up to 25% of the tax. If the IRS determines that your failure to file was attributable to fraud, the penalty will be 15% per month up to 75% of the tax.
Thus, you are always better off filing the tax return by the due date, even if you don’t have the funds to pay the tax because you will not be assessed the failure to file penalties.
3. Report all of your income shown on the Form 1099’s that you have received. Even if you don’t receive a 1099, you still have to report all of your income. If you file your tax return without reporting all of your income, you are risking an audit. If the IRS audits your tax return and finds omitted income, you will be assessed tax on the omitted income plus interest on the tax computed from the due date of the tax return to the date that the tax is paid.
Then, the IRS will apply the 20% accuracy related penalty or the 75% fraud penalty on the additional tax plus the interest on the penalties computed from the due date of the tax return to the date that it is paid.
4. Don’t deduct an office in a home. To qualify for an office in a home deduction, you must use the office for work and it must be your primary place of business. Most taxpayer’s abuse this deduction.
Unless, your office in the home is your primary place of business, don’t take this deduction. Further, let’s say that you properly documented that you used 15% of your residence for business, when you sell the residence, the IRS will correctly argue that 15% of the gain from the sale is taxable income. This will create unintentional tax liability on your part. Unless you have a compelling reason to take this deduction, stay away from it.
5. Don’t deduct a large Sch C loss, unless you truly have a loss. A large Sch C loss means that your business deductions exceeded your income from the activity.
The IRS will be questioning you on the source of the funds to pay for those excess deductions. You will need to document sources of the non-taxable income to pay for that loss. If you sold assets to fund the loss, you will need to document those sales.
The possible sources of the non-table income would include loans, gifts and inheritances. These sources will have to be documented to the IRS, if requested by them.
The documentation would include copies of checks, closing papers, gift tax returns of the person who made the gifts and estate tax returns for inherited funds.
6. Don’t deduct a loss from a business activity that the IRS can classify as a hobby loss, unless you have the documentation for that loss.
If you deduct a loss from a horse racing, dog racing, car racing, a boat chartering activity or any other activity that is fun; the IRS will ask you to prove that the activity is engaged for profit.
Thus, you should have a separate bank account for these activities and a business plan on how you expect to make a profit from the activity. You will need to show valid business projections.
7. When you deduct donations of property to a charitable organization, you need to have the required documentation that will always include a valid appraisal. Only deduct what you actually donated to the charitable organizations and can verify with copies of cancelled checks.
8. When you deduct a casualty loss, you need the proper documentation for the deduction. The documentation will always include an appraisal of the property before and after the casualty.
The amount reimbursed by insurance for the casualty. You will also need to prove your adjusted basis in the property before the casualty.
If you have a theft loss, make sure that you report the theft to the police and obtain a police report for the incident.
9. You should always be prepared for an audit by having in your possession all of the documents needed to verify the items shown on your tax return even before it is ever audited.
You do not want to search for the verification after your tax return has been selected for audit by the IRS.
10. If you are selected for a tax audit, call Fresh Start Tax LLC to ensure the best possible results.
