How does IRS Identify Cases with Audit Potential?

Understanding how the IRS identifies cases that have audit potential can be learned from the CONGRESS OF THE UNITED STATES (CONGRESSIONAL BUDGET OFFICE) Report released on July, 2020: Trends in the Internal Revenue Service’s Funding and Enforcement.  This report addresses IRS trends in funding, staffing and detailed views of tax law enforcement.

IRS Enforces Tax Laws Via its enforcement activities:

• Auditing tax returns,
• Collecting unpaid taxes,
• Obtaining tax returns from taxpayers who did not file returns on time,
• Correcting mathematical or clerical errors,
• Using software to flag questionable refunds, and
• Verifying information reported by taxpayers against information from third parties.

The IRS creates an inventory pool of returns that have audit potential

The inventory pool selection varies by the type of return and by the IRS unit responsible for conducting an audit. 

Some of the pool selection mechanisms are the following:

1. Computer Screening. Computer algorithms score the probability of noncompliance on individual and corporate income tax returns.
2. Data Discrepancies. Discrepancies between information provided to the IRS by third parties (states, employers, banks, payment processors, brokers, or other federal agencies) regarding income or dependents claimed on a return.   
3. Focus Area. In the case of large and international businesses, a return may be selected for examination because it has characteristics that match an issue-based area of focus, called a “campaign.” The Campaigns identify narrow issues that represent a high risk of noncompliance and select returns with those issues for audit or for notices intended to educate the taxpayer.
4. Related Returns. When an examination is opened, prior or subsequent returns filed by the taxpayer, or returns filed by related taxpayers like business partners, may also be selected for examination.
5. Referrals. Taxpayers suspected of noncompliance can be referred for IRS examination by federal, state, or local government agencies, or by citizen whistleblowers.
6. Mandatory Review. Certain types of returns are always examined because of law or IRS policy. IRS examines all returns that claim a refund of more than $2 million (or $5 million for C corporations) and submits a report to the Joint Committee on Taxation.  Other returns that are routinely examined include those of certain IRS employees, the President, and the Vice President. Examiners also review amended returns, which must be manually processed.
7. Random Selection. The IRS National Research Program (NRP) selects a random sample of returns for examination to provide the agency with information about voluntary compliance.

The IRS will address taxpayer noncompliance related to unreported income, undisclosed assets, or any other tax avoidance scheme

The IRS currently has 53 Active compliance campaigns.  Taxpayers that are out of tax compliance ought to discuss their coming into compliance options with their tax specialist.