Audits Increased for Individual, Corporate, and S Corporation Tax Returns

A Treasury Inspector General for Tax Administration Report (number 2011-30-071) reported that the number of audits increased for individual, corporate, and S corporation tax returns in the 2010 Fiscal Year.  Despite the increase, the report noted a decrease in the number of partnership audits.

The report attributed the rise to an increased number of IRS agents and tax compliance officers resulting in the greatest amount of tax returns examined over the past five years,

The majority of these examinations were conducted by correspondence as opposed to an office audit, or field audit.

Why am I being audited?

Below discusses several possibilities as to why you are being audited

Discriminate Function System
A Discriminate Function System (DIF) is a statistical profile that is computed by comparing income, expenses, and deductions using data for taxpayers in similar income brackets.  The DIF score can identify which returns deviate from the norm.

The IRS matching Program
The IRS receives tax information from third parties such as the following:

  • Employers/Wages (Form W-2)
  • Greater than $600 for individual services (Form 1099-Misc)
  • Gambling/Casinos (Form W-2 G)
  • Pensions/Annuities (Form 1099-R)
  • Mutual Funds/Financial Planners (Form 1099-Div)
  • Banks/Interest (Form 1099-INT)
  • State Unemployment and State Income Tax Refunds (Form 1099-G)
  • Mortgage Interest (Form 1098)
  • Partnership (Schedule K-1)
  • Student Loans (Form 1098-E)

The IRS reviews each information return and compares it to the return you submitted.  Any discrepancy in what was reported to the IRS versus what you submitted will be automatically adjusted by the IRS computer system.

Market Segment Specialization Program
The IRS selects various industries or professionals to audit which is known as the Market Segment Specialization Program (MSSP).  For example, there was an MSSP on the tobacco, wine, veterinary, aerospace, farming, tanning and a myriad of other industries.  The program enables the IRS to create guides that help tax examiners audit a particular industry.

Informants and Random Audits
The IRS may receive tips from informants, gather information from federal, state, and local enforcement of evidence of criminal activity, or pick a return to audit at random.

The IRS announced that it plans to begin random audits for its National Research Program (NRP). These audits will be more intrusive than a traditional audit and the data gathered will be used to update the computer system for DIF.  The NRP project will focus on worker classification (employee vs. independent contractor status), fringe benefits, executive compensation, and reimbursed expenses.  The IRS is randomly selecting 2,000 employers to audit for each year over the next few years.

Some Good News
Despite the increase in audits, the Treasury Inspector General for Tax Administration Report indicated that the rate for no change, meaning the taxpayer substantiated all items under review, increased for individual income tax returns.

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