The audit lottery, or preparing for the TCMP audit - again! (Taxpayer Compliance Measurement Program)

• Author: Kauls, Laura J.

Generally, only about 1% of all individual income tax returns are audited. Thus, the IRS employs several techniques for selecting returns to examine in order to use its audit time most efficiently.

Selection process

After the initial checks, information on returns is processed by computers and rated for potential errors by a selection program known as the Discriminate Function System (DIF) - a statistical analysis that assigns number values to various items on the return and thereby produces a composite score for each return. There are numerous possible formulas for weighing the data to calculate the composite score, but the exact formulas are withheld from the public. The standards used in developing these formulas are based on the results of examinations from previous years, particularly the results of the Taxpayer Compliance Measurement Program (TCMP). Representatives from IRS district offices screen those returns that have significant DIF scores, and agents evaluate these returns to determine the potential for adjustment versus the costs of the examination.

The DIF formulas used to determine which returns should be audited are updated using information received from the TCMP. The TCMP selects random returns and subjects them to a thorough audit that examines every aspect of the return. During a TCMP, the taxpayer may be required to furnish the examiner with marriage certificates, birth certificates, cancelled checks, deposit slips, receipts and any other item that might be needed to verify every entry on the return. These other items could include casino earnings, U.S. Customs reports, foreign bank account information, motor vehicle registration data, etc. Full compliance with TCMP audit procedures by IRS field agents is mandatory, which makes it time-consuming and expensive to the taxpayer (as well as time-consuming and frustrating to the tax practitioner).

In addition, because these audits attempt to "scientifically" measure the degree and extent of taxpayer compliance, returns selected for audit must be examined. The only accepted reasons for avoiding a TCMP audit are: * The taxpayer is outside the United States and unavailable for an interview. * The taxpayer cannot be located. * The taxpayer is too ill, has become incompetent or has died, and the guardian or executor cannot be located.

The AICPA's Tax Practice Management manual suggests that there have been reported instances of practitioners getting TCMP audits waived on grounds...