The Eight Types of Audits

There are eight types of audits that can affect your return:

Mathematical Correction Audits — These audits are usually generated by a computer program to find mismatches between names and social security numbers, earned income credit qualifications, filing status issues, estimated tax and withholding tax errors, assessments of estimated tax and late filing penalties and interest or almost any other issue. Sometimes these audits require an appointment for these matters to be examined and sometimes the IRS assumes that they are correct and includes a recalculation of the tax return with a tax balance due, including interest and penalty assessments for you to pay. Even if they issue a bill, we have 30 days to schedule an appointment to prove your numbers are correct.

Income Document Matching Audits — These audits are usually generated by a computer program that is matching all 1099 forms, W-2 forms, K-1 forms, etc. that were issued to your name and social security number to what is reported on your tax return. If the IRS believes that you did not report all of your income based on their computations, they will audit this tax return. They might send you a letter requiring a phone call to schedule an appointment, or they will preschedule an appointment date and time, or they might send you a bill itemizing why you need to pay more, including interest and penalties. Even if they issue a bill, we have 30 days to schedule an appointment to prove that you properly reported your income.

DIF Scoring — Every tax return filed is given a discriminant function (DIF) score. The score is based on secret calculations developed by the IRS to identify returns with the highest likelihood of tax change on audit. The DIF score increases for various items on a return (such as Schedule C or auto expenses) and decreases for other items (such as using a paid preparer). IRS classifiers review high DIF-score tax returns, select those that will be audited and decide which items on the tax return will be audited.

Correspondence Audits — These audits require that documentation for an item or items on the tax return be mailed to the IRS auditor, sometimes to an IRS office on the other side of the country. The documentation includes both the receipts and the proof of payment for whatever items are being examined. For example, if your charitable contributions are being audited, you will need to provide copies of the receipts from the charitable organizations and copies of the canceled checks to verify the numbers that you reported on your tax return. Any contribution that you cannot prove will be disallowed and the IRS will issue a bill for the balance due, including interest and penalties.

Office Audit and Field Audit — These are the face-to-face audits that have received the most publicity in the last several years. Congressional pressures on the IRS and an increase in funding have resulted in dramatic increases in the audit rate. This type of audit starts with a telephone call or letter from the IRS. The intent of the telephone call, which is used exclusively in many areas, is to get the taxpayer to volunteer information long before the face-to-face meeting. This information would never be revealed by our qualified representative. During the audit appointment, the IRS will examine items on the tax return that could result in a larger tax bill. Based on the results of the audit, other tax years will also be examined.

Random Audits — In order to improve the IRS’s audit selection process, the IRS randomly selects individual tax returns for audit. This audit plan, called the National Research Program is the successor to the Taxpayer Compliance Measurement Program (TCMP). This audit is certainly the most intrusive by its very nature. Every entry on the tax return can be examined, line by line. For instance, if a child was claimed as a dependent, you will need to provide the birth certificate to prove that the child is yours and proof that the child was actually living with you in the tax year being audited. The IRS is currently performing these audits nationwide.

Financial Status Audits — These audits focus on the taxpayer’s standard of living and other factors not specifically related to the tax return. Auditors use public records and statistical data to trace spending and changes in wealth to prove that you, the taxpayer, have unreported income. Records examined include tax returns for all open years, credit reports, property tax records, business license applications, motor vehicle records, 1099 information, currency transaction reports and SEC filings.
Due to perceived abuses of these techniques, Congress limited their use in the IRS Restructuring and Reform Act of 1998. Under Section 7602(e), the IRS cannot use financial status or economic reality techniques unless the IRS already has a reasonable indication that there is a likelihood of unreported income. The statute (law) does not define "reasonable indication."

IRS Special Project Audits — The IRS annually identifies twelve of the most blatant tax scams. This list is called “The Dirty Dozen” and identifies many areas that will cause an audit. This list is worth reviewing. http://www.irs.gov/newsroom/article/0,,id=206370,00.html