IRS Audit – How Returns Are Selected

June 5, 2016  | By Erik Lincoln

The IRS selects returns to audit using a variety of methods, including:

  • Computer Scoring. Most individual returns are selected for examination on the basis of computer scoring. However, other types of returns can also be selected by the use of computer scoring. Computer programs give each return numeric “scores.” The Discriminant Function System (DIF) score rates the potential for change, based on past IRS experience with similar returns. DIF is defined as a mathematical technique used to classify income tax returns as to examination potential. The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported income. IRS personnel screen the highest-scoring returns, selecting some for audit and identifying the items on these returns that are most likely to need review. ,
  • Manual Selection. Most returns, other than individual returns, selected for audit are selected manually by IRS personnel using one or more risk assessment criteria.
  • Taxpayer disclosures—Disclosures on Forms 8275 (Disclosure Statement), 8275-R (Regulation Disclosure Statement), 8886 (Reportable Transaction Disclosure Statement), and 8938 (Statement of Specified Foreign Financial Assets) could trigger an audit.
  • Schedule M-3—Book-tax differences can trigger an audit, particularly if they are large, permanent differences.
  • Industry issues—The IRS identifies common tax issues within industry groups and often surveys returns in a particular industry to determine if they contain any such issues.
  • Large Corporations. The IRS examines many large corporate returns annually.
  • Information Matching. Some returns are examined because payer reports, such as Forms W-2 from employers or Forms 1099, such as interest statements from banks, do not match the income reported on the taxpayer’s return.
  • Related Examinations. Returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners, investors, family members, or corporate officers or shareholders, whose returns were selected for examination to determine whether the taxpayer under examination has correctly reported his or her tax.
  • Multiple Years. A multiple year examination may occur when the agent determines to expand his or her examination to years prior to the year at issue or years subsequent. For example, an agent may be looking at net operating loss carrybacks or carryforwards or consistency of treatment of a particular item on the return. By opening another year for examination, the agent has jurisdiction over the return and can make appropriate adjustments to all years under examination.
  • Claims and Requests for Refund. When a claim for refund is submitted, the original return and the refund claim are screened to determine if an examination is warranted before paying the refund.
  • Other—Examination Priorities. Certain programs of the IRS that focus on specific issues can also result in an audit. Examples of these programs are:
    • National Research Program
    • Abusive Tax Avoidance Transactions (ATAT)—Offshore and Domestic
    • ATAT Promoters
    • Offshore Evasion
    • High Income Taxpayers (HITS)
    • High Income Non-Filers (HINF)
    • Special Enforcement Program (SEP)

Erik Lincoln is a founding member of Lincoln. In addition to being an attorney he is also a CPA. Erik has consistently been recognized as one of the top attorneys in North Carolina, by Business North Carolina.