Once again, we are hearing about the IRS targeting various taxpayers. Recently the Kansas City Star analyzed a new study by the National Taxpayer Advocate. This study used confidential IRS information to view the tax compliance of businesses. What this group found out is that the IRS feels that construction industry or the real estate rental firms are most likely to cheat on their taxes. Having the ability to be able to hide income is one of the criteria the IRS uses when deciding who will be audited.

This discovery doesn’t exclude other small businesses, however. Sole proprietorships, more so than the different corporate structures, are also targeted, for again, the IRS feels that sole proprietorships have more opportunity than others to be dishonest. Since sole proprietorships make up about 65% of all small business, this affects a significant number of people and businesses annually.

Discriminant Inventory Function or DIF

Because the IRS only has the resources to maybe audit 1% of the returns, they are going to try to pick returns which will yield tax money from the audit. The IRS does not give out any details on how they pick a tax return for audit, we do know that they run every tax return through a special, confidential computer program, looking for good audit candidates.

The program then assigns a score to the tax return, and the higher scored tax returns have a much greater chance of being audited. The Discriminant Inventory Function (DIF) is the name of this score, and the IRS says that a high score does not mean that you are a tax evader, but on the other hand, the agency also says that score is very reliable in finding errant tax money. According to the IRS, that high DIF score will probably result in an audit that will probably result in a change in your tax liability.

No information has ever been released that tells what criteria can give you a high DIF score, but people who have analyzed the patterns claim that unusually high deductions or expenses which are not in proportion to income create an immediate red flag for the IRS.

The DIF score is weighted differently for the various American industries. As we stated previously, the construction industry and real estate rental companies usually score very high. On the other hand, accountants, lawyers, architects, and other professionals usually score much lower. If you are a sole proprietorship in a business with the ability to hide income, you can become a target whether you deserve it or not.

A good way to score low as possible in your industry is to report your income and expenses honestly, and then have good records to back up all of your claims. If you do have tax problems, call Jeff Fouts, Tax Lawyer, and he can work with you to resolve the issues. He is known for getting problems solved.