Are Tax Audits Random? How the IRS Selects Returns

Tax audits are not entirely random. While a small fraction of returns are selected without specific indicators, most are chosen based on data analysis and identified risk factors. The Internal Revenue Service (IRS) employs various methods to pinpoint returns with errors or discrepancies, ensuring targeted enforcement. Understanding these processes helps taxpayers manage compliance.

How the IRS Selects Returns for Audit

The IRS primarily uses a data-driven approach to select tax returns for examination. One principal tool is the Discriminant Function System (DIF) score, a confidential algorithmic system that assigns a numerical score to tax returns. A higher DIF score indicates a greater likelihood of error, prompting review and prioritization for audit.

Another significant method is information matching. The IRS receives copies of financial documents, such as W-2s from employers, 1099s for independent contractor income or investment gains, and K-1s from partnerships. The agency compares information reported on these third-party forms with what taxpayers report on their tax returns. Discrepancies, such as unreported income or mismatched figures, can trigger an automated flag and lead to an inquiry or audit.

Audits can also stem from related examinations. If a taxpayer has financial ties to an individual or entity undergoing an audit, their return may also be selected for review to investigate interconnected financial activities. A very small percentage of returns are chosen at random through the National Research Program (NRP). These detailed examinations gather data on taxpayer compliance, helping refine the DIF system and identify non-compliance areas.

The IRS increasingly uses advanced technology, including artificial intelligence (AI) and data analytics, to enhance audit selection. These technologies process vast data, identify complex patterns, and detect potential non-compliance efficiently. AI systems analyze tax returns with electronic information from diverse sources, identifying subtle discrepancies and risk profiles.

What Increases Your Likelihood of Audit

Certain financial behaviors and reporting can significantly increase the chances of an IRS audit. A common trigger is unreported income, especially from sources not subject to third-party withholding (e.g., gig economy earnings, cryptocurrency transactions, foreign income). The IRS receives information from numerous sources; failing to report all taxable income can lead to discrepancies that flag a return.

Claiming unusually high itemized deductions relative to income can draw scrutiny. If deductions on Schedule A appear disproportionately large compared to a taxpayer’s gross income, it may signal a need for review. Sustained business losses, particularly for self-employed individuals reporting on Schedule C, can be a red flag if they resemble hobby losses rather than legitimate business activities. The IRS looks for a profit motive and may question continuous losses without a clear path to profitability.

Large charitable contributions, especially significant non-cash donations or very high cash contributions compared to income, can invite an audit. Taxpayers must maintain proper documentation (e.g., receipts or appraisals) to substantiate these deductions. Mathematical errors or inconsistencies between different forms and schedules are easily detected by IRS systems and can lead to immediate inquiries or audits. Claiming certain tax credits with historically high error rates, such as the Earned Income Tax Credit (EITC) or specific child tax credits, can increase audit likelihood. The IRS audits a disproportionate number of EITC claims to ensure eligibility and accuracy, often through correspondence audits.

Types of Audits and What to Expect

An IRS audit can take one of several forms, each with varying levels of intensity and interaction. The most common type is a correspondence audit, conducted entirely by mail. These audits typically address minor issues or discrepancies, such as missing documentation for a specific deduction or a mismatch in reported income. The IRS sends a letter requesting additional information or documentation (e.g., receipts for expenses or proof of income).

If issues are more complex than what can be resolved through mail, the IRS may conduct an office audit. This audit requires the taxpayer to meet in person with an IRS agent at a local IRS office. Office audits often focus on specific sections of a return, such as itemized deductions (Schedule A), business profits and losses (Schedule C), or rental income and expenses (Schedule E).

The most comprehensive type is a field audit, occurring at the taxpayer’s home, business, or accountant’s office. Field audits are typically reserved for complex individual or business returns requiring in-depth examination of financial records and operations. Regardless of the audit type, the IRS requests specific documentation to support claims made on the tax return.

Understanding an Audit Notice and Initial Steps

Receiving an IRS audit notice can be unsettling, but immediate steps are crucial. First, verify the notice’s legitimacy; legitimate IRS communications arrive by mail, not by phone calls or emails demanding immediate payment or personal information. The notice is typically on official letterhead and does not include threats of immediate arrest or legal action.

Next, carefully read the notice to understand the audit’s scope. The letter specifies which tax year is under review and often highlights particular items or issues the IRS is questioning. This helps focus efforts on gathering relevant information.

Once the scope is clear, begin collecting all pertinent documentation (e.g., receipts, invoices, bank statements, canceled checks, and other records) that support the audited items for the specified tax year. Organizing this documentation systematically is beneficial. Create a clear, labeled system for all requested documents to facilitate easy retrieval and presentation.

For audits beyond a simple correspondence audit, or if issues are complex, consider consulting a qualified tax professional (e.g., a Certified Public Accountant (CPA), Enrolled Agent, or tax attorney). These professionals provide guidance and can represent the taxpayer. Do not ignore the notice; failing to respond by the stated deadline can lead to unfavorable outcomes, including the IRS disallowing deductions or assessing additional tax and penalties.

The Audit Process

After receiving an audit notice and preparing documentation, the next steps involve responding to the IRS and presenting information. For correspondence audits, the response typically involves mailing copies of requested documents to the IRS address provided in the notice. For office or field audits, the notice specifies an appointment date or requests that the taxpayer schedule one.

When submitting documents, always send copies and retain originals for personal records. If attending an in-person audit, bring organized documents, but only provide information directly related to the auditor’s questions. Maintain a professional demeanor and avoid offering unnecessary details that could broaden the audit’s scope.

Taxpayers have specific rights during an audit, including the right to representation and the right to appeal IRS decisions. Understanding these rights helps ensure a fair process.

The audit can conclude with several possible outcomes. A “no change” outcome means the IRS accepts the return as filed. An “agreed” outcome indicates the IRS found discrepancies, and the taxpayer agrees with proposed adjustments and any additional tax due.

A “disagreed” outcome means the taxpayer does not agree with the IRS’s findings. The taxpayer has the right to appeal the decision within the IRS Office of Appeals, or even in Tax Court. This appeal process allows for an independent review of the case.