People typically think that the amount of their income is the biggest red flag that attracts an IRS auditor, and they would probably be right. But what are some of the other items on a tax return that may attract their attention? Some say that simple, plain returns are fairly safe and likely to avoid extended scrutiny by IRS auditors. According to the IRS, there are multiple ways a return may end up audited, here are some examples:
Discriminant Information Function, or DIF
The IRS has a computer-scoring system for reviewing returns known as the Discriminant Information Function, or DIF. Not many individuals, even tax experts, really know much about the DIF and its components. The IRS evaluates tax returns based on IRS formulas, while the DIF is based on deductions, credits and exemptions, establishing norms for taxpayers in each income bracket. Some say that one DIF function component looks at the amount of a return’s average deductions, which exposes any inconsistencies to auditors.
Examples of Red Flags:
• Income-related Red Flags.
Higher income amounts as well as income that is received in a form other than basic wages. Another thing that draws the attention of auditors is any income that is unreported.
• Business-related Red Flags.
Home-based businesses, especially those with home office deductions tend to draw questions from auditors. There is particularly IRS concern in situations where such a business exists and supposedly generates income in addition to salaried employment and income. Large business meal, auto and entertainment deductions are suspect. Also, returns that claim losses from an activity that may likely be a hobby rather than a business will not go unnoticed by IRS auditors.
• Noncash charitable deductions.
Proof in such cases is difficult. Can the donated property’s value be clearly ascertained?
• Large casualty losses.
Substantiating these losses is also difficult. A common question is whether the property’s value may be overstated.
Returns claiming the earned income tax credit, which is a tax break for lower-income wage earners, also get special attention. Some are legitimate mistakes; others are false claims to increase the amount of the credit. Taxpayers that use and file Schedule C to report a business loss also are more likely to receive a second or third look from the IRS.
One reliable way to get IRS’ attention is to fail to report a Form 1099 income. If you receive a Form 1099 for a payment but fail to report the income on your tax returns, you are almost certain to get the IRS’ attention, and not in a pleasant way.
In conclusion, the only way to truly stay out of the IRS’ way is to fully comply with tax laws.
If you have received an audit letter from the IRS and have related questions or concerns, call THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.
