Tax and Audit
In the United States of America, an income tax audit is the examination of a business or individual tax return by the Internal Revenue Service (IRS) or state tax authority. The IRS and various state revenue departments use the terms audit, examination, review, and notice to describe various aspects of enforcement and administration of the tax laws.Employers and financial institutions, among other organizations, are required by law to send documentation (W-2’s and 1099’s, for example) to the IRS. The IRS uses software to ensure that the numbers on a tax return match the numbers the IRS receives from third parties. If the documentation does not match, the return may be examinedWhen a tax return is filed, the IRS uses computer software called the Discriminant Index Function System (DIF) to analyze the return for oddities and discrepancies.Once the return has been processed through DIF, it is given a score. If the DIF score is high enough (i.e. a large amount of oddities or discrepancies are found), that tax return may be selected for examination. The formulas the IRS use to create the DIF software and analysis are a closely guarded secretFiled tax returns are also subjected to an evaluation called the UIDIF, or the Unreported Income Discriminant Index Function System. This evaluation involves the analysis of tax returns based on a series of factors to determine a tax return’s potential for unreported income. Returns that are found to have a high UIDIF score (i.e. the likelihood of unreported income) and a high DIF score may be selected for examination. The IRS formulas used to calculated UDIF are secret, but it is commonly thought that the IRS uses statistical comparisons between returns to determine UIDIF potentialon
The IRS selects a certain number of income tax returns to be audited each year through random selection. No errors need to be found for the Enforcement branch to examine a tax return. Random selection exams tend to be more extensive and time-consuming than other forms of reviewAudit representation, also called audit defense, occurs when a tax or legal professional stands in on behalf of a taxpayer during an examination. Federal law and all states allow a taxpayer to have an authorized representative. The representative must have permission to practice before the IRS or state, and specific credentials are required. The types of representatives who are allowed to represent taxpayers before the IRS in income tax audits include attorneys, certified public accountants (CPAs), and enrolled agents.