Getting audited by the IRS is becoming rare. In 2018, the IRS audited about 0.5% of returns filed. This is a 42% reduction from the audits conducted in 2010 and about 66% less than the number of audits from about 50 years ago.
Why is the IRS conducting fewer audits? The short answer is that they have less money. This means fewer people and less time to review and audit returns. There have also been policy changes, such as the IRS placing greater emphasis on customer service instead of enforcement. Finally, there have been new laws that have reduced the IRS’ ability to enforce potential tax violations.
Despite these changes, the threat of an audit is still very real. In this blog post, we’ll discuss some of the more recent IRS tax audit trends and what taxpayers need to be aware of.
Rise of the Machines
One of the IRS’ best tools for identifying tax issues is the computer. The IRS has a computer system that reviews returns and creates special Discriminant Function System (DIF) scores. These DIF scores help the IRS decide if a return needs further review.
How the IRS calculates these DIF scores is not public knowledge. However, we know that it creates a DIF score by comparing a given return to other similar returns and checks to see if anything stands out.
For example, if the return for a small business is claiming expenses or deductions that are significantly higher than what most similar small business returns would claim, that might result in a DIF score that leads to a human review and possibly, an audit.
Thanks to the coronavirus, there have been a plethora of changes to tax laws, especially new provisions to help businesses and individuals hard hit by the pandemic. For instance, there are the Paycheck Protection Program loans, changes as to how health insurance marketplace premium credits are calculated and increased opportunities for tax refunds for businesses suffering unusual operating losses because of the coronavirus pandemic.
The IRS is almost guaranteed to be on the lookout for taxpayers who have made mistakes when utilizing these benefits or have tried to engage in fraudulent activities. Taxpayers also need to keep in mind that as the coronavirus vaccine distribution continues and states start opening up more, the IRS’ enforcement efforts will also likely continue to ramp up. There was a point during 2020 when the IRS dramatically scaled back its auditing and other tax enforcement activities.
The IRS is trying to catch up to Bitcoin and other cryptocurrencies. One way the IRS is doing this is by asking taxpayers to properly report their virtual currency transactions.
In the past, these requests were made on special tax forms, like a Schedule 1 (Form 1040). Now, this request is on Form 1040 itself. This means everyone who files a return is likely going to have to report their virtual currency transactions, assuming they have them.
One of the biggest reasons for changes in how the IRS conducts audits is the coronavirus. The coronavirus has led to a host of new changes to the tax laws, which has required the IRS to adjust what it looks for in a tax return that could lead to an audit. If you have any questions about these new changes, don’t hesitate to speak with your tax professional.