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Will your return be chosen for review? Here's what the IRS looks for.The
IRS accepts most tax returns as filed, however, a small percentage of individual returns
are audited to verify the correctness of reported income, deductions, and credits. In
recent years, there has been a steady decline in the number of individual returns audited.
According to the IRS Data Book, approximately 1.7 million returns (or 1.28
percent of all individual returns filed) were audited in fiscal 1997, down from 2.1
million in fiscal 1995.
Audit Process: The IRS conducts audits in several different ways. Some
examinations are handled by mail. Others may take place in the taxpayer’s home or
place of business, an IRS office, or the office of the taxpayer’s representative.
Individual returns are selected for either a field audit by a revenue agent or an office
audit by a tax auditor, based on the complexity of the issues and the degree of accounting
and auditing skills required to perform the examination properly. Depending on the nature
of the issues, office audit returns are subject to either a correspondence audit or an
interview examination.
Selection Methodology: There are several methods by which the IRS
selects returns for audit. A computer program, the Discriminant Function System (DIF),
selects many of the individual returns that are audited. Under DIF, the entries on a
return are evaluated and the return is given a score. IRS personnel then screen the
returns and select those most likely to include mistakes. The IRS also selects returns by
(1) examining claims for refund; (2) using information received in other audits or from
informants; and (3) following examination programs or guidelines for specific
businesses/industries. In the past, additional returns were selected at random under the
Taxpayer Compliance Measurement Program (TCMP); however, this program has not been
utilized recently because of decreases in funding.
In addition to the above, the IRS service centers operate audit programs that focus on
specific noncompliance issues, including:
- Matching Information: The IRS uses a computerized document matching
program to correlate third-party information statements related to wages, interest,
dividends, and certain deductions (for example, Form 1099–DIV, Dividends and
Distributions, Form 1098, Mortgage Interest Statement) with the amounts reported on the
individual’s income tax return. This matching program also allows the IRS to identify
people who are reported to have received income but did not file returns. When return
information does not agree with filed information documents, the taxpayer is asked to
explain the discrepancy. The taxpayer is sent a letter that explains the proposed
adjustment, the balance (or refund) due, and his/her appeal rights. This correspondence
serves as a 30-day letter -- the taxpayer may respond by requesting an additional
explanation, supplying documentation/explanation, or requesting an Appeals conference. If
the taxpayer does not respond, a notice of deficiency is issued.
- Unallowable Items: This program identifies and corrects items on the
return that are not allowed by law. Examples include (1) claim of surviving spouse status
for more than two years; (2) loss on sale of personal assets; (3) duplicate deductions;
(4) deduction of FICA taxes, utility taxes, or auto license and tag taxes; (5) charitable
contributions for the value of a taxpayer’s time or labor; and (6) deduction of
personal legal expenses (for example, wills, adoption, divorce). If problems are found,
the taxpayer receives a letter explaining the proposed corrections.
- Alimony Compliance: Returns claiming alimony deductions are matched
with returns reporting the receipt of the alimony payments.
- Federal-State Comparison: Examination reports from state tax agencies
are reviewed to determine if changes to the federal return are necessary.
- Mathematical or Clerical Errors: The IRS automatically identifies and
corrects mathematical and clerical errors on returns, and assesses any additional tax due.
A "mathematical or clerical error" includes (1) an error in addition,
subtraction, multiplication, or division; (2) an incorrect use of an IRS table; (3) an
entry on a return that is inconsistent with another entry on the return; (4) a deduction
or credit that exceeds the statutory limit, if the limit is expressed as a specified
monetary amount or as a percentage, ratio, or fraction and the items used in computing the
limit appears on the return; (5) an omission of a correct taxpayer identification number;
and (6) a claim for a credit with respect to net earnings from self-employment to the
extent the tax on such earnings has not been paid. If an error is identified, the IRS
sends a notice of correction explaining the adjustment to the taxpayer. The taxpayer then
has 60 days after the correction notice is received to file a request for abatement of the
assessment. The tax is automatically abated when a timely request is made, and the IRS
service center performs an examination to determine whether the proposed adjustment is
appropriate.
- Self-Employment Tax: The IRS identifies income that may be subject to
self-employment tax (for example, income from a sole proprietorship or partnership, income
from rendering services as an independent contractor).
These are some thoughts to consider about tax benefits for adoption. Your Deloitte & Touche financial advisor also can provide
information and should be consulted before any action is taken.
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