WASHINGTON – Worried the Internal Revenue Service might target you for an audit? You probably should be if you own a small business in one of the wealthy suburbs of Los Angeles.
You might also be wary if you’re a small-business owner in one of dozens of communities near San Francisco, Houston, Atlanta or the District of Columbia.
A new study by the national taxpayer advocate used confidential IRS data to show large clusters of potential tax cheats in these five metropolitan areas. The IRS uses the information to target taxpayers for audits.
The taxpayer advocate, Nina Olsen, runs an independent office within the IRS. She got access to the data as part of an effort to learn more about why some taxpayers are more likely to cheat than others.
The study also looked at tax compliance in different industries and found that people who own construction companies or real estate rental firms may be more likely to fudge their taxes than business owners in other fields.
Many of the communities identified by the study are very wealthy, including Beverly Hills and Newport Beach in California. Others are more middle class, such as New Carrollton, Md., a Washington suburb, and College Park, Ga., home to a section of Atlanta’s massive airport.
Steve Rosansky, president and CEO of the Newport Beach Chamber of Commerce, said business owners in his city are probably targeted because many have high incomes. The likelihood of an audit does increase with income, according to IRS data.
“I imagine it’s just a matter of them going where they think the money’s at,” Rosansky said in an interview. “I guess if I was running the IRS I’d probably do the same thing.”
The study focused on small-business owners – sole proprietorships, to be specific – because they have more opportunity than the typical individual to cheat on their taxes. Many small businesses deal in cash, while most individuals get paid in wages that are reported to the IRS.
The IRS only audits about 1 percent of tax returns each year, so the agency tries to pick returns that are most likely to yield additional tax money.
The IRS will not say much about how agents choose their targets. But as millions of procrastinators scramble to meet today’s deadline to file their taxes, the agency is running every tax return through a confidential computer program to determine the chances of collecting more money from an audit.
Each tax return is assigned a score. The higher your score, the more likely you are to get audited because, according to the IRS, the more likely you are cheating on your taxes.
The score is called the Discriminant Inventory Function, or DIF. A high DIF score does not guarantee you are a tax cheat, but the IRS says it’s reliable.
How do you get a high score? The IRS won’t say, but veteran tax preparers and former IRS workers believe they have a pretty good idea.
“If you’re reporting $8,000 of charitable contributions when you’re only making $50,000, that’s a red flag,” said Bob Meighan, vice president of TurboTax, an online tax preparation service. “Likewise, if you’re reporting business or employee expenses that are out of the ordinary for your income range, that would attract the interest of the IRS as well.”