Audit-Misconception #2

"Each year I file my tax return around April 15th
because it reduces my chances of being audited."

This misconception, started a few years ago by another tax author, was based on an erroneous assumption about the IRS's computer system.

During the processing routine all tax returns are scored or rated for audit potential under IRS's top secret computer program called DIF, for Discriminant Function. The higher the DIF score, the greater the potential of bringing in additional taxes under the audit. The IRS strives to audit the higher-scored returns first BECAUSE of the expectation of getting more revenue for government coffers. DIF scores are developed from an analysis of a series (involving up to 50,000 randomly selected returns) of intensive audits, conducted every few years, called the Taxpayer Compliance Measurement Program (TCMP). In a TCMP audit, the IRS will analyze every item on the tax return, including proof of income. (DIF scores therefore reflect correlated averages found on a cross-section of tax returns.)

The assumption behind this misconception is that a cut-off score of 240 may be the high cut-off score in February when fewer returns are filed, but 260 may be the cut-off score in April when more returns are filed. Therefore, if your DIF score is somewhere between 240 and 260, then your chances of being audited are lessened by filing in April when everyone else files.

This misconception is based on a poor understanding of how returns are selected for audit. The selection process does not even begin until after the end of June, over two months past the end of the April 15 deadline. The first step occurs when computer-selected returns are arranged in batches of examination class, a method used to categorize returns by the amount of income reported. All returns are placed into one of 12 classes based on their total positive income (TPI) for individuals or total gross receipts (TGR) for businesses. (See Exhibit 5-3 in Chapter 5 for a breakdown of each TPI and TGR category, the number and percentage of returns audited and the average tax and penalty recommended per return in each category.)

Throughout the year, district IRS offices place orders with the IRS service centers for returns to audit. The service center then pulls those returns that are above a specific DIF cutoff score and sends them to the district office. Districts are required to order returns numerous times over a twelve-month period so that all tax returns, regardless of their filing date, have an equal chance of being delivered to the district for classification,a manual selection procedure performed by revenue agents called classifiers.

Another aspect of the selection system is the actual classification process. The IRS requires that the highest DIF scores within each examination class be pulled and manually screened for audit potential by the classifier. A high DIF score is "any return with a score above the median score delivered for each examination class."

If it appears to the classifier that the tax return is in order or that you have included sufficient substantiating or appropriate documentation with the return, the return will most likely be sent back to the service center without being audited. The classifier relies of his or her experience, judgment, and instincts to analyze the returns to find the ones with the greatest likelihood of change.

This interesting part of this whole process is that while the classifier receives a high Dif-Score return, the various items on the return that resulted in the high DIF score are not identified. Therefore, the classifier must decide what items on the tax return will be questioned during the audit. More than any other non-DIF factor, the classifier's decision is the most significant variable in the selection process. See Exhibit 0-1 for IRS guidelines to classifiers on how to identify significant issues when selecting returns for audit.

Agents with classification experience have stated that subjective factors frequently enter into the selection process. For example, one classifier selected returns that were sloppily prepared, or ones that had a lot of rounded numbers in the expense columns (for example, $25,000 for travel expenses instead of $24,679). Another agent stated he selected returns that were prepared by certain commercial tax preparers.

The fact is you cannot influence your DIF score, and you should not try by fooling around with the expense figures on your return. But you may be able to influence the classifier's decision and reduce your chances of being audited by following this simple rule that may turn out to be the single most important audit-proofing strategy rule in the entire book:

AUDIT-PROOFER'S STRATEGY RULE

If you want to reduce your chances of being selected for an audit, you should attach supporting and substantiating documentation to your return.

While attaching documentation to the tax return is not commonly done, and frowned on by the IRS, a classifier may not bother with selecting your tax return for audit if the items under question are supported with photocopies of canceled checks, or legal documents, or other records. You are not required to send supporting and substantiating documentation at the time of filing, but by doing so you can make a constructive contribution to reduce your chances of being audited.

It is not necessary to include supporting documentation on every item, just the ones that you think are unusual enough to be questioned. But if you really want to play it safe, attach a copy of every supporting document you have- but never send an original document with your tax return; it could be lost. Don't worry if your tax return is one inch thick- the IRS is used to fat packages. Use a large brown envelope if you have to. Generally it is a safe strategy to inundate them with paper.

Next Section: Audit Misconception #3

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© 1986, 1998 to 2002, Jack Warren Wade, Jr.