Small Business Finance News

Computer Scores, Not Politics Drive Audits, Says IRS Chief

Written by Tim Morral
Published: 7/31/2013

In the wake of the recent IRS scandal, the IRS offers important insights about the factors that may trigger audits for small businesses.

Across the board, small business owners dread IRS audits--and with good reason. Based on IRS statistics, the agency recovered more than $50 billion through enforcement actions in 2012, including the audits of 350,000 small business returns.

How IRS Decides Who to Audit

The IRS is clearly motivated to initiate audits. But the recent scandal involving the inappropriate targeting of returns for political reasons has shined a spotlight on how and why the IRS launches investigations. In some instances, it's alleged that the IRS conducted audits based on political labels rather than using objective criteria for audit selection.

To counter these claims, IRS Acting Administrator Daniel Werfel appeared before the House Small Business Committee to describe the process the IRS uses to identify organizations and returns that warrant closer scrutiny.

According to Werfel, the IRS doesn't consider political activity to be a sufficient reason to launch an audit investigation. Instead, the IRS uses computer scoring to assess a business or an organization's risk of noncompliance.

The computer scoring system the IRS uses takes into account a variety of factors, including differences between reported income and information provided by third parties (e.g. W-2s and 1099s). If computer scoring uncovers a single issue, the IRS sends a letter; if it uncovers multiple issues, the IRS will schedule a face-to-face meeting.

For small business owners, knowing how to avoid an IRS audit is an important skill, especially since unexpected tax liabilities can strike a serious blow to budgets and growth plans. By matching reported income to third party reporting mechanisms and consulting a qualified tax professional, small business owners can mitigate their risk and insulate their companies against the possibility of IRS reviews and audits.

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