DIY Tax Auditing Prediction

Via Bargaineering:

In 2006, they published a page on the IRS.gov website that details exactly how they determined which tax returns to audit. It comes down to these four main ways (for individuals):

• Computer Scoring – I listed this one first because it’s the most interesting of the four reasons. Tax returns are “scored” using two systems – Discriminant Function System (DIF) and Unreported Income DIF (UIDIF). The Discriminant Information Function System (DIF) score gives the IRS an indication of the potential for change in tax due, based on past IRS experience. The Unreported Income DIF (UIDIF), as you can imagine, scores the return on the potential for unreported income. The higher the score, for either, the more likely the return will be reviewed.
• Information Matching – This is an obvious reason because it’s the easiest to catch. The IRS receives the same W-2s and 1099s that you do, so it’s trivial for them to compare the two totals. If they don’t match, they investigate.
• Related Examinations – Beware who your friends/business contacts are! If their returns are audited and their return includes transactions with you, your return may be audited as well.
• Potential participants in abusive tax avoidance transactions – The IRS may get information about promoters of and participants in various schemes and select a return for audit based on that information.

For those interested in a more scientific approach, see this classic in the JEL from Andreoni, et al.