Many people believe in the myth of the “audit lottery.” The audit lottery myth encourages the perception that the IRS chooses returns to audit at total random. Under a completely random system, taxpayers who have accurate and correct information on their tax returns would have the same chance of being audited as taxpayers who have missing, incorrect or false information.
However, the audit lottery is a wished for myth. While even the IRS’ own characterization of the selection process may further the audit lottery myth with the use of the words “random selection” for only one minor audit selection process.
IRS Commissioner Doug Shulman Declares Audit Lottery a Myth
In a speech at the National Press Club in April, 2011, IRS Commissioner Doug Shulman declared that while he has heard people refer to the “audit lottery,” the “process is far from random.” The IRS uses “sophisticated risk models” to identify compliance problems. The statistical formula noted above is actually not meant to help randomize things but to use the IRS’ “cumulative knowledge and data…to model the risk of tax avoidance.”
This means that those who are using certain strategies to avoid tax liability are far more likely to be audited than those who do not, since the IRS has formulas based on certain “norms” to detect common fraudulent strategies. While a taxpayer who gets an audit notice may suspect or be told that the tax return was chosen randomly, that is probably not the case. The selection processes used by the IRS are actually targeted at those tax returns that the IRS believes have a likelihood of tax avoidance or fraud.
IRS Audit Selection Processes
Among the processes for selecting which tax returns will be audited:
1. D.I.F. [Discriminant Income Function]. This is an IRS computer program that examines all tax returns filed for a statistical variation of what the IRS believes is the “normal average amount”. DIF has sixty-six different categories, some of them secret, to determine which tax returns have the most “audit potential”; i.e. the most likely to be wrong. Among the DIF categories that are not secret is the total income:
- Income: the higher the income, the more likely the person is to be audited; although the IRS insists that everyone has a potential for being audited, even the lowest paid person without any deductions can be audited,
- Deductions: the total deductions, as well, as the type of deduction, as well as the percentage of the deductions as compared to the national statistical model,
- Losses: especially business and real estate losses,
- Self Employed People: the IRS believes that the self-employed person has a far greater opportunity to falsify his or her tax return in many ways, such as not reporting all of their income, or inflating or creating deductions, or deducting personal expenses as business expenses.
2. Document Matching. Various entities (e.g., employers, retirement funds, and banking institutions) that make certain payments to taxpayers must submit tax forms to the IRS with the amounts paid. If the payee files a tax return with amounts that do not match what the IRS has received from the payor, the payee or the payor may be audited.
3. Related Examinations. If the tax return of a certain taxpayer is being audited, the associates, business partners, or others involved with the audited taxpayer may also be selected for audit.
4. Random Selection.The IRS sometimes selects returns based on a statistical formula.
5. TCMP. This is a special extremely detailed audit where every line of the tax return is scrutinized to determine the effectiveness of the D.I.F. program and to adjust the D.I.F. program as needed.
If you are facing an IRS or State audit, our experienced attorneys at The Law Offices of Steve Moskowitz, LLP want to help. We have represented numerous clients through the complex and often frightening experience of having your previous tax returns audited and scrutinized by the Government in an audit. Call us today for your free attorney-client privileged consultation.