Why YOU Were Selected for a Tax Audit by the IRS
South Floridians have always wondered how and why they were selected for an IRS Tax Audit. The IRS audits over 1.4 million tax returns annually and taxpayers are fearful of being audited. The answer may seem overly simple, but most people do not have knowledge of the audit process.
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.
- High DIF scores
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.
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 2013 Proposed Budget, the IRS has increased appropriations again to increase resources for the Enforcement Division. This includes investigations, examinations and collections.
Other Reasons why IRS selected your tax return for an IRS audit
1. High income.
If your income is $200,000.00 and over; the audit rate will be one-in-twenty seven of being audited. If your income is $1,000,000.00 or more, the audit rate will be one-in-eight of being audited. This is just a fact of life.
2. Failing to report all of your taxable income.
The IRS receives copies of all 1099′s, W-2′s, W-2G’s and K-1′s that you receive. If the income from the 1099′s, W-2′s, W2G’s and K-1′s are not shown on the tax return, the tax return will be audited.
3. Deducting the home office deduction.
The space used in your home must be used “exclusively and regularly” as your principal place of business. “Exclusive use” means that a specific area of the home is used only for trade or business. If you can prove the home office deduction, then take it. If you can’t prove it, don’t take it.
4. Deducting large charitable contributions.
If your charitable deductions are large compared with your income, the return will be audited. The IRS is aware of what the average charitable donation is for a given income level. If you have donated and deducted a conservation easement to a charity, chances are good that you will be audited.
5. Deducting rental losses.
Normally, the passive loss rules prevent rental losses from being deducted. There are two exceptions, if you actively participate in the renting of your property, you can deduct up to $25,000.00 of the loss against your other income; but this $25,000.00 limitation phases out as adjusted gross income exceeds $100,000.00. The second exception applies to real estate professionals who spend more that 50% of their working hours and 750 or more hours each year materially participating in reals as a developer, broker, landlord or the like. The IRS will be requesting that you prove the required hours, especially if are a full time employee.
6. Deducting business meals, travel and entertainment.
The IRS has specific record keeping requirements for these type of deductions. The IRS is aware that many taxpayers overstate these type of deductions.
7. Deducting losses from a hobby activity.
If you treat your favorite hobby as a business on your tax return with a net loss, you have a good chance of being audited. If you are audited, you will need to prove that your activity is a profit making activity and not a costly hobby. So make sure that you run your activity in a businesslike manner and can substantiate your expenses with supporting documents.
8. Running a cash business.
If you are in a cash-intensive business, like taxis, car washes, bars , hair salons, restaurants, you will be audited. The IRS is aware that individuals who primarily receive cash, don’t report all of their taxable income. The IRS has various audit techniques to determine unreported cash income.
9. Failing to report a foreign bank account.
If you fail to report a foreign bank, you will be assessed large penalties. If you have any signature authority over a foreign bank account, you will need to consult with a tax professional to determine the correct reporting requirements for that account.
10. Engaging in currency transactions.
If you are engaged in cash transactions in excess of $10,000.00, the IRS will receive reports of these transactions from the financial institutions. Further, if you engage in suspicious cash activities, the IRS will receive a “suspicious-activity report” from the various financial institutions.
These transactions usually indicate that the the taxpayer is trying to hide income from the IRS. Try to avoid these type of transactions.
We are a local South Florida tax firm comprised of tax attorneys, certified public accountants, enrolled agents and former IRS agents, managers and tax instructors who have over 60 years of combined work experience at the Internal Revenue Service in the local South Florida offices.
We have worked as IRS audit agents, revenue agents, IRS audit managers and supervisors and lastly IRS appellate agents.
We know every aspect of IRS tax audits and we are true local experts that can handle tax audits of any kind.
We have been in private practice since 1982 right here in South Florida and have an A+ rating by the Better Business Bureau. We are available for free tax consultations and we can fully review your case and give you the various options and methods of resolution. We truly are IRS tax audit experts.