Does the IRS Do Random Audits? How Audits Are Selected

The notion of a “random audit” by the Internal Revenue Service (IRS) is a common misconception among taxpayers. While a very small fraction of audits are part of a specific research initiative, the vast majority are not arbitrary. Instead, the IRS employs strategic methods and sophisticated data analysis to identify tax returns that are most likely to contain errors or discrepancies. This targeted approach allows the IRS to efficiently allocate its resources towards ensuring tax compliance, rather than conducting widespread, untargeted examinations.

How Audits Are Selected

The IRS utilizes various non-random methods to select tax returns for examination. One primary method involves data analysis through computer programs, such as the Discriminant Function (DIF) system. Every tax return receives a DIF score, a numerical rating based on historical data indicating the likelihood of inaccuracies. A higher score suggests unusual information, leading to further review by IRS personnel who then decide if an audit is warranted.

Another significant selection method is information matching. The IRS compares the income and payment information reported by third parties, such as employers (W-2s) and financial institutions (1099s), with what taxpayers report on their returns. Discrepancies, like unreported income, can trigger an inquiry or audit. If these discrepancies are identified, the IRS may send a CP2000 notice, which proposes changes to the tax return based on the mismatched information.

Audits can also arise from related examinations; if an individual or business connected to you is audited, your return might also come under scrutiny. This “audit by association” ensures that interconnected financial activities are consistently reviewed. Additionally, the IRS may initiate audits as part of specific compliance initiatives, focusing on particular industries, types of transactions, or tax issues where non-compliance is suspected. Returns with higher incomes or complex financial situations often face increased scrutiny due to the potential for more significant tax implications. Even simple math errors or missing information on a tax return can lead to an inquiry, although these might be resolved through correspondence rather than a full audit.

Types of IRS Audits

Once a tax return is selected for examination, the IRS conducts the audit in different formats depending on the complexity of the issues and the amount of documentation required. The most common type is a correspondence audit. These audits typically address specific, less complex issues like missing documentation for deductions or discrepancies in reported income, often involving a request for additional information.

For more complex issues that cannot be resolved through mail, the IRS may conduct an office audit. These audits require the taxpayer to meet with an IRS auditor at a local IRS office. Office audits generally focus on specific areas of a tax return, such as itemized deductions, business profits or losses, or rental income and expenses.

The most comprehensive type of examination is a field audit. In a field audit, an IRS agent conducts the examination at the taxpayer’s home, place of business, or the office of their tax representative. These audits are usually reserved for intricate business returns, high-net-worth individuals, or situations where extensive financial records need to be reviewed in person. The agent may review financial records, interview employees, and tour the premises to verify reported information.

The Audit Process

The audit process begins when a taxpayer receives an official audit notice by mail; the IRS will never initiate an audit by telephone. This notice, which might be a CP2000, specifies the tax year being examined, the issues under scrutiny, and the documentation the IRS is requesting. It also indicates the type of audit to be conducted: correspondence, office, or field.

Upon receiving an audit notice, taxpayers should carefully review its contents and understand the stated deadlines. Promptly gathering all requested documents, such as receipts, invoices, and bank statements, is essential to substantiate claims made on the tax return. Taxpayers typically have about 30 days to respond to the initial inquiry, with extensions sometimes available.

The collected information is then provided to the IRS examiner. During the examination phase, the examiner reviews the submitted documents and may ask additional questions to clarify any discrepancies or ensure a complete understanding of the financial situation.

An audit concludes with one of several outcomes. A “no change” outcome means the IRS found no issues and accepted the return as filed, requiring no additional tax or adjustments. If the IRS proposes adjustments, the taxpayer can either “agree” with the findings, which typically involves signing an agreement form and paying any additional tax, interest, or penalties. Alternatively, if the taxpayer “disagrees” with the proposed adjustments, they have the right to appeal the IRS’s decision. This allows for further discussion and potential resolution through the IRS Appeals Office.