The IRS Audit / Exam Process

If you’ve ever been audited by the IRS then you would probably agree that it is one of the most stressful ordeals of your life.  Some people worry themselves sick about their potential for audit before they even hear from the IRS.  It is useful to understand some of the IRS audit selection criteria so you can deal with the things that are within your control and not worry about the things that aren’t.

The IRS tends to use the terms “exam,” “examination,” and “audit” interchangeably.  These are all terms they use for the process of examining, clarifying, and correcting errors on one or more tax returns.  As you can imagine, the IRS does not have the resources to carefully pick through each line of each return.  Instead, the IRS picks out certain returns with a high likelihood of containing errors, and these are some of the selection methods:

  • Computer Scoring:  The IRS’ Discriminant Function System (DIF) is a computer program that flags returns based on a numeric score.  A return that has a higher likelihood of problems (such as unreported income) gets a higher score.  Then the high-scoring returns are reviewed by human eyeballs and some of them are selected for audit.
  • Information Matching:  The IRS compares payer reports (1099s, W-2s, etc.) and public records to what is claimed on the tax return and may select returns for audit based on discrepancies.
  • Related Examinations:  If you are affiliated with people or entities that were selected for audit, your chances of being audited may be higher because when the IRS finds problems with one return, they have found that others may be lurking near.
  • Informants:  Some returns are selected for audit based on anonymous tips or are the result of extensive investigation into tax evasion schemes.
  • Large Corporations:  And finally, some large corporations must submit to routine examinations (often yearly) simply because they generate huge profits and the stakes are too high for the IRS to miss anything.

If you do get selected, you should know that the vast majority of audits are completed without ever meeting face-to-face with the IRS.  Here are the different types of audits:

  1. Service Center Examinations (very simple, few issues, math error or something of that nature)
  2. Office & Correspondence Exams
  3. Field Examinations (Revenue Agent goes to your home or place of business to physically inspect your books)

http://www.irs.gov/uac/The-Examination-(Audit)-Process