One of the biggest fears people have is receiving an audit notice from the IRS. This fear ranks right up with the diagnosis of a life-threatening illness on most taxpayers’ lists. Of course, the IRS does nothing to alleviate this fear. They reason that the more fearful you are, the less likely you will be to cheat on your taxes. The chance of being audited is actually quite remote for most people and not everyone stands the same chance of being audited. According to the IRS website, based on 2007 audited tax returns, it selects returns for examination in five ways:
- Computer scoring by DIF (discriminate information function), a formula used to select returns for review;
- National Research Project;
- Local and national projects that look at particular areas of the return;
- Information matching, such as Forms 1099; and
- Related returns.
Some of these methods are entirely random. If your return is pulled, it is just the (bad) luck of the draw. However, the DIF system is not a random-selection process. Based on a closely guarded formula, the DIF system analyzes tax returns for oddities and discrepancies. The DIF system scores returns and those with the highest DIF scores are examined by experienced IRS agent to determine if audits are warranted.
The table below is preliminary data from 2009 returns. It shows a comparison of key write-offs claimed by taxpayers at various income levels. The IRS does not automatically audit you if you have above average deductions in any of these areas. If your deductions are disproportionately large compared to your income, your audit risk can go up because it is part of the DIF formula.
Though you may not fall outside of these averages, your tax return may still come to the attention of the IRS. Here are a few more ways to avoid drawing attention to your return:
- Unreported Income ‑The IRS has many reporting sources that are matched with your return in an effort to be sure all income is being reported. Interest and dividends are reported on Form 1099. Wages are reported on Form W2. Pensions, Social Security income, tax refunds and self-employment income are all reported as well. The best way to guarantee an IRS query is to forget to report income.
- Round Numbers — Round numbers do not happen very often in the real world. Capital gains are rarely exactly $1,000. Round numbers are an indication that you are estimating rather than keeping good records. If your mortgage interest is $983, don’t round it off to $1,000. Report the exact amount.
- Matching State & Federal Returns – Most states are now sharing information with the federal government. Make sure the information you report to the state is the same as what you put on your federal tax return.
- Mathematical Errors — Double-check your return before filing to make sure all your numbers add up properly. A math error on your return will cause it to be flagged and someone will have to check it to determine what caused the error.