Don't Mess With Taxes

We're a week away from Tax Day 2014. Some folks, however, are dreading the months, and possibly years, after the annual April deadline.

That's when they will get to know the Internal Revenue Service better as it audits their returns.

IRS Commissioner John Koskinen noted the always-present possibility of tax audits when he spoke last week at a National Press Club luncheon:

"[T]axpayers need to be confident that the IRS will treat them fairly. It doesn't make any difference who they are, what organizations they belong to, or whom they voted for in the last election. None of that matters to us at the IRS. We will do about one million audits of individual taxpayers this year.

Some who get audited may be Democrats, some may be Republicans, and others may be something else altogether. But they will all have one thing in common: They're being contacted by us because there was something on their tax returns that needed follow up. Perhaps we just need a clarification. Maybe there was a mathematical error. Or there could be something seriously wrong with the return.

But the return alone is the reason for our inquiry. And anyone else with the same issue would receive the same treatment from the IRS."

Koskinen's remarks obviously were framed by the ongoing controversy about how the IRS reviewed applications by groups for 501(c)(4) tax-exempt status.

But the commish also got me thinking about how the IRS picks those one million or so 1040s that are reviewed more closely. When you consider that this year nearly 150 million returns are expected to be filed, one million doesn't seem that big of a number.

It's plenty big, however, if you're one of those one million. That's why the annual audit total is this week's By the Numbers figure.

Waving audit red flags: And today's Daily Tax Tip looks at some other numbers that could be audit red flags.

Sure, there are professions that get extra IRS attention. They're the ones where cash payments are typical. It's easier to hide amounts that way than it is for payments made by check or credit card.

Such third-party verification also make small businesses, especially sole proprietors who file Schedule C with their Form 1040, tax examination targets. In this case, there are lots of deduction options -- home office, meals and entertainment -- that might catch an auditor's eye.

And if you're rich, watch out. Yes, you're already getting whacked by added taxes, but the IRS is no fool. It knows it needs to send its limited number of auditors after the folks who are more likely to produce higher payments after their returns are checked.

In most instances, however, Koskinen is right. The IRS is pretty egalitarian about who it audits. That's because it uses a set of numbers to make the first computer cut of returns that might eventually be audited.

The machine doesn't know who you are personally. It just knows that some of your entries don't fall within its discriminant information function parameters.

What's the DIF? The discriminant information function, or DIF, looks at average deduction amounts. Specifically, it looks at how returns vary from those averages.

Inconsistencies, such as a high mortgage interest deduction and low income, could be a sign to IRS examiners that they need to look at a return.

So how do you know if your claims are within the range that the IRS computer finds acceptable? The agency isn't saying what its numbers are, but tax information publisher and software maker CCH makes an educated guess each year.

Using the latest complete filing data available from the IRS, CCH puts put together a table showing the average amount of popular deductions found on Schedule A in various income ranges. The table below is based on preliminary 2011 amounts; remember, IRS reports lag because of the time needed to compile figures.

SOURCE: Wolters Kluwer, CCH: 2014

CCH reminds us that the averages take into account only those individuals who claimed an itemized deduction for that type of expense. Zero deductions are not factored in.

So the average taxpayer with adjusted gross income between $50,001 and $100,000 did not take an average medical expense deduction of $7,376, only the average taxpayer who itemized did.

Also, cautions CCH, these numbers are for our information and, if you're a tax geek (and you probably are if you're here!) entertainment only. Do not base your itemized deductions on these figures.

You also might find these items of interest:

• If IRS asks, you've got some 'splaining to do
• How to avoid a tax audit, virtual or otherwise
• Selfies used as tax claim documentation, audit defense