What’s the DIF?
The IRS uses a complex set of formulas to evaluate tax returns: this is called the Discriminant Inventory Function System, or DIF. The system compares deductions, credits, and exemptions against the norm for each income bracket, and returns are given a DIF score.
While the IRS closely guards the specifics of DIF formulas, we do know that certain factors increase your chances of being selected for audit. These include:
- Income. If you earn a higher income than average, you will likely be flagged. This is not because you have done anything wrong or have been dishonest; it is simply because the IRS will generate more revenue by auditing higher-income people than lower-income taxpayers.
- Occupation. The IRS wants to ensure that people with jobs that produce cash income (wait staff, taxi drivers, etc.) pay their fair share. If you are employed in these types of fields, your risk of being audited is higher. This is also true of independent contractors, who may have unreported cash income.
- Certain Deductions. If you claim certain deductions — particularly home office, travel, and entertainment — the IRS will pay much closer attention to your returns. These are areas in which some taxpayers find it easy to be less than honest.
- No/Problem Tax Preparer. The IRS maintains a “problem preparer” list: if your preparer is on it, then you will likely be flagged for audit. Likewise, if you prepare a complex return yourself, your chances of facing an audit are greatly increased.
- Tax Protests. If you’re thinking of claiming the dollar is worthless or that you owe no taxes because you don’t recognize the authority of the government, for example, the IRS will deem it a frivolous tax protest, and you will find yourself in the hot seat.
- Abuse Tax Shelters and Offshore Accounts. Use of offshore accounts and credit cards are often seen as an attempt to evade paying income taxes in the US. Rest assured, the IRS is cracking down on these abuses.
- Family Matters. If you have financial transactions with family members (e.g. pay wages to children, run a family business, lend money to relatives, etc.), your risk of audit is higher.
The Best Defense Is a Good Offense
Under the law, the IRS has three years from the due date of your return to launch an audit — unless there is suspicion of fraud or underreporting of income. If you are audited: breathe. Preparing for the possibility is essential. How?
- Keep records and receipts for all deductions and credits. If, for example, you’re claiming a deduction for work-related travel, keep a mileage log and fuel receipts.
- Trust a seasoned tax professional to prepare your return. While there is no way to completely eliminate the possibility of an audit, you can protect yourself by having an experienced preparer on your team.
- If you receive notice that you are being audited, see your accountant immediately. Remember, sometimes audits are random, and you’ll simply have to provide appropriate documentation. Regardless, your accountant can help you find the information the IRS needs quickly.
Audit anxiety is very real: Faw & Associates works to reduce the stress and fear so, even if you are selected, you can face the process with confidence — and the best chance of a successful outcome. Contact us to schedule an appointment.