
[ Back ] We Can Help With Your Tax Problems! IRS AUDIT MATTERS - THE AUDIT LOTTERY For fiscal year ended September 30, 2007 the Internal Revenue Service audited 0.8% of all individual tax returns and 1.34% of all corporate returns filed. The number of individual income tax returns audited by the IRS has been increasing since 2000. Taxpayers should be cautious in relying upon overall low statistics. Individual returns (Form 1040) with total proprietorship business receipts between $100,000 and $200,000 had 3.8% audit rate. Individual returns reflected more than $1,000,000 in income had a 5.6% audit rate. The greater a taxpayer's reported income, the greater the chance that an individual's return will be audited. For example, individuals earning in excess of $100,000.00 are nine times as likely to be audited as those individuals earning less than $25,000.00. Taxpayers who file a Schedule C (proprietorship business return) are much more likely to be audited than a taxpayer employee who has W-2 income and high itemized deductions. With regard to corporations, high income and high asset corporations are much more likely to be audited than small corporations. For example, the IRS audits approximately 95% of all corporate tax returns which have gross assets in excess of $20,000,000.00. The IRS audits approximately 1.3% of those corporate returns reporting under $100,000.00 in assets. The IRS relies heavily on its computer system to select tax returns for audit. Each return received by an IRS Service Center is statistically scored to determine its audit potential. The system is known as the Discriminate Function System (DIF). IRS computers analyze two primary measures in determining DIF score: total positive income and total gross receipts. Total positive income is the sum of all income items on a return. With regard to personal income tax returns reporting business receipts (Schedule C and Schedule F) gross business income is the primary focus. The IRS believes that business gross receipts are better indicators of audit dollars than net business income reported on the return. For non-business tax returns, other items on an individual's return will act as red flags alerting the IRS to consider sending the taxpayer a written inquiry or worse, conducting an examination of that taxpayer's return. Some of the red flags are as follows: If the Service Center must write the taxpayer concerning missing schedules and that taxpayer fails to respond, that return will generate higher DIF scores. Omission of Form 8283 (Non-Cash Charitable Contribution) will raise the DIF score. Failure to file an Alternative Minimum Tax Schedule (Form 6251) on a Form 1040 will increase chances of audit. Casualty losses will increase chances that a taxpayer will be audited. An affirmative answer with respect to foreign bank accounts will increase the chance of audit. Returns which claim tax credits will receive a higher DIF score. High itemized deductions (e.g., mortgage payments and real estate taxes) relative to total positive income reported on a return will create a higher DIF score. Multi-year Schedule C losses, without intervening years of net income, will increase DIF scores. Form 1099 income reported to the IRS but not appearing on a taxpayer's income tax return will, at a minimum, invite correspondence from the Internal Revenue Service. A lack of federal income tax withholding on a taxpayer's Form W-2 (Employer Statement of Earnings) may flag a taxpayer as non compliant and perhaps a tax protester. Schedule C gross sales in relation to net profit for a particular business code will raise DIF scores. High itemized deductions in comparison to other residents of the same geographical area, will raise DIF scores. Lifestyle audits are becoming more common. The appearances of availability of more funds than reported as income on the return wll figure into the DIF score. High mortgage interest and real estate taxes relative to a taxpayer's level of income is an indicator for possible audit selection. The IRS utilizes several different examination techniques to determine the accuracy of tax returns. At an IRS Service Center, computers are utilized to verify the computations shown on each return. The Service Center also conducts correspondence audits by initiating letters to taxpayers requiring verification of deductions and/or exemptions shown on a return. Office audits, conducted by junior IRS account representatives, are conducted in local IRS offices. Field examinations are conducted by Revenue Agents on more complex Form 1040 returns. Revenue Agents are college degreed accountants. An additional word of caution. The October 1, 2008 IRS budget called for an increaase in IRS enforcement personnel across the board. For example, IRS Revenue Agent staffing is going up 22% from 5,000 field agents to 6,100 agents. This staffing increase will be in place by December of 2009. [ Back ]

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We Can Help With Your Tax Problems!

IRS AUDIT MATTERS - THE AUDIT LOTTERY

For fiscal year ended September 30, 2007 the Internal Revenue Service audited 0.8% of all individual tax returns and 1.34% of all corporate returns filed. The number of individual income tax returns audited by the IRS has been increasing since 2000. Taxpayers should be cautious in relying upon overall low statistics. Individual returns (Form 1040) with total proprietorship business receipts between $100,000 and $200,000 had 3.8% audit rate. Individual returns reflected more than $1,000,000 in income had a 5.6% audit rate.

The greater a taxpayer's reported income, the greater the chance that an individual's return will be audited. For example, individuals earning in excess of $100,000.00 are nine times as likely to be audited as those individuals earning less than $25,000.00.

Taxpayers who file a Schedule C (proprietorship business return) are much more likely to be audited than a taxpayer employee who has W-2 income and high itemized deductions. With regard to corporations, high income and high asset corporations are much more likely to be audited than small corporations. For example, the IRS audits approximately 95% of all corporate tax returns which have gross assets in excess of $20,000,000.00. The IRS audits approximately 1.3% of those corporate returns reporting under $100,000.00 in assets.

The IRS relies heavily on its computer system to select tax returns for audit. Each return received by an IRS Service Center is statistically scored to determine its audit potential. The system is known as the Discriminate Function System (DIF). IRS computers analyze two primary measures in determining DIF score: total positive income and total gross receipts. Total positive income is the sum of all income items on a return. With regard to personal income tax returns reporting business receipts (Schedule C and Schedule F) gross business income is the primary focus.

The IRS believes that business gross receipts are better indicators of audit dollars than net business income reported on the return. For non-business tax returns, other items on an individual's return will act as red flags alerting the IRS to consider sending the taxpayer a written inquiry or worse, conducting an examination of that taxpayer's return. Some of the red flags are as follows:

If the Service Center must write the taxpayer concerning missing schedules and that taxpayer fails to respond, that return will generate higher DIF scores.
Omission of Form 8283 (Non-Cash Charitable Contribution) will raise the DIF score.
Failure to file an Alternative Minimum Tax Schedule (Form 6251) on a Form 1040 will increase chances of audit.
Casualty losses will increase chances that a taxpayer will be audited.
An affirmative answer with respect to foreign bank accounts will increase the chance of audit.
Returns which claim tax credits will receive a higher DIF score.
High itemized deductions (e.g., mortgage payments and real estate taxes) relative to total positive income reported on a return will create a higher DIF score.
Multi-year Schedule C losses, without intervening years of net income, will increase DIF scores.
Form 1099 income reported to the IRS but not appearing on a taxpayer's income tax return will, at a minimum, invite correspondence from the Internal Revenue Service.
A lack of federal income tax withholding on a taxpayer's Form W-2 (Employer Statement of Earnings) may flag a taxpayer as non compliant and perhaps a tax protester.
Schedule C gross sales in relation to net profit for a particular business code will raise DIF scores.
High itemized deductions in comparison to other residents of the same geographical area, will raise DIF scores.
Lifestyle audits are becoming more common. The appearances of availability of more funds than reported as income on the return wll figure into the DIF score. High mortgage interest and real estate taxes relative to a taxpayer's level of income is an indicator for possible audit selection.

The IRS utilizes several different examination techniques to determine the accuracy of tax returns. At an IRS Service Center, computers are utilized to verify the computations shown on each return. The Service Center also conducts correspondence audits by initiating letters to taxpayers requiring verification of deductions and/or exemptions shown on a return. Office audits, conducted by junior IRS account representatives, are conducted in local IRS offices. Field examinations are conducted by Revenue Agents on more complex Form 1040 returns. Revenue Agents are college degreed accountants.

An additional word of caution. The October 1, 2008 IRS budget called for an increaase in IRS enforcement personnel across the board. For example, IRS Revenue Agent staffing is going up 22% from 5,000 field agents to 6,100 agents. This staffing increase will be in place by December of 2009.

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Cincinnati Tax Lawyer
4555 Lake Forest Drive Suite 365
Cincinnati, OH 45242

Phone: (513) 563-4555
Fax: (513) 563-9097
E-Mail: tjutaski@cincinnatitaxlawyer.com