The IRS selects tax returns for audit primarily through three methods:
1) Computer Algorithm (DIF System):
- This algorithm, known as the Discriminant Function System (DIF), is a secret computer program that assigns a score to tax returns based on various factors. Although secret, the algorithm likely compares the current return with past returns, looks at industry norms, and utilizes IRS statistics to identify returns with a high likelihood of errors or issues.
- Returns flagged by the algorithm are reviewed by IRS personnel who may further investigate specific line items or issues.
2) Random Selection:
- The IRS also conducts random audits to gather statistical data and to establish a baseline for what is typical on tax returns. These audits help refine and improve the accuracy of the IRS’ computer algorithms.
- Random audits are less common than those triggered by the DIF system but are essential for IRS research and audit strategy development.
3) Other Miscellaneous Methods:
- Audits can be initiated based on tips or referrals from whistleblowers or other taxpayers reporting suspected tax evasion or fraud.
- Audits can also arise from related audits of family members, business associates, or entities associated with the taxpayer currently under audit.
- Some large corporations and businesses are audited regularly due to their size and complexity.
In summary, while the exact workings of the IRS’s algorithm are secret, it plays a pivotal role in selecting tax returns for audit based on perceived risk of errors or issues. Random audits and other miscellaneous methods also contribute to IRS audit selections, though to a lesser extent compared to the algorithmic approach.
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