The Discriminant Index Function

Any tax relief attorney would love to know exactly how the IRS selects returns for audit, but the IRS only gives hints here and there, leaving us to piece it all together ourselves.  A recent TIGTA audit report offers some insight into the process:

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The IRS developed a variety of sources to select returns for audit. The IRS strives to select for audit those returns for which its examiners are likely to find areas of noncompliance and recommend changes to one or more items reported on the return. One audit source is the Discriminant Index Function (DIF) system, which the IRS has relied on over the years to help decide how to best allocate its audit resources. The system uses mathematical formulas to calculate and assign a score to returns based on their audit potential. The higher the score, the greater the chance an audit will result in recommended changes to the return.

~ TIGTA Report No. 2012-30-062 (June 21, 2012)

So, we know there are mathematical formulas involved.  We know the IRS is looking for returns with errors or “areas of noncompliance.”  And we know that one of the resources the IRS turns to for determining which returns to select for audit is the Discriminant Index Function (DIF).  There appear to be multiple formulas and multiple systems involved in the audit selection process.It just so happens that the subject of this TIGTA report is S-Corp Form 1120-S audits.  TIGTA is concerned by the high number of “no-change” 1120-S audits, reporting that the IRS has been wasting time reviewing perfectly good returns resulting in no additional tax owed and not tax debt.