Audit Risk May Depend On Where You Live

Taxpayers and preparers, worried that their returns may trigger an audit, should take special care if the return is for a small business owner in one of the wealthier suburbs of Los Angeles.  Or, for that matter, one who lives in San Francisco, Houston, Atlanta, or the District of Columbia.

A new study by the National Taxpayer Advocate used confidential IRS data to show large clusters of potential tax cheats in these five metropolitan areas. The IRS uses the information to target taxpayers for audits.  The taxpayer advocate, Nina Olsen, runs an independent office within the IRS. She got access to the data as part of an effort to learn more about why some taxpayers are more likely to cheat than others.

The study also looked at tax compliance in different industries, and found that people who own construction companies or real estate rental firms may be more likely to fudge their taxes than business owners in other fields.

Many of the communities identified by the study are very wealthy, including Beverly Hills and Newport Beach in California. Others are more middle class, such as New Carrollton, Md., a Washington suburb, and College Park, Ga., home to a section of Atlanta’s massive airport.

The study focused on small-business owners — sole proprietorships, to be specific — because they have more opportunity than the typical individual to cheat on their taxes. While most individuals get paid in wages that are reported to the IRS, many small businesses deal in cash.

The IRS only audits about one percent of tax returns each year, so the agency tries to pick returns that are most likely to yield additional tax money.

The IRS will not say much about how agents choose their targets. But the agency is running every tax return through a confidential computer program to determine the chances of collecting more money from an audit.  Each tax return is assigned a score. The higher your score, the more likely you are to get audited because, according to the IRS, the more likely you are cheating on your taxes.

The score is called the Discriminant Inventory Function, or DIF. A high DIF score does not guarantee you are a tax cheat but the IRS claims it’s reliable.

How do you get high score? The IRS won’t say, but people who take unusually large deductions for their income get a high score. Also, business owners who claim unusually large expenses for the size and type of their business get a high score.

Source:  IRS National Taxpayer Advocate

by Dave McClure, Industry Writer