DIFferent deduction amounts could trigger an IRS audit

One of the biggest taxpayer fears is being audited. Realistically, unless you're aggressively pushing the tax envelope, it's not something that should keep you up at night.

That's not just my assessment. It's borne out by Internal Revenue Service data, which shows that the individual tax return audit rate in 2016 was just 0.06 percent. That's the fifth straight year audits (or examinations, as the IRS calls them) have dropped and the number of returns examined last year was the fewest since 2004.

A key reason that audits have fallen is because the IRS is understaffed in this area. (More on this in a minute.)

What's the DIF? But the initial audit filter the IRS uses to pull returns for closer looks is automated. It's the agency's computer-scoring system known as Discriminant Information Function, or DIF.

The IRS evaluates tax returns based on IRS formulas it has created from years of data collection. The DIF is based on deductions, credits and exemptions with norms for taxpayers in each of the income brackets.

While the IRS doesn't release its actual DIF figures, tax industry analysts can parse much of the same data the tax agency uses. And these numbers crunchers typically release the average deductions that they believe influence the IRS' initial audit choices.

Using the latest complete filing data available from the IRS, Wolters Kluwer Tax & Accounting put together a table, reproduced below, showing the average amount of popular deductions found on Schedule A in various income ranges.

SOURCE: Wolters Kluwer 2017  

Wolters Kluwer's table is based on preliminary 2014 amounts. Remember, IRS reports lag because of the time needed to compile figures.

Also, note 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 $9,614; only the average taxpayer who itemized did.

Also, cautions Wolters Kluwer, 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.

IRS agents and the audit rate: So who at the IRS looks more closely at the returns that are flagged because of their notably different DIF numbers? Not that many.

IRS Commissioner John Koskinen touched on this problem during his annual assessment of the tax season this week, both in a speech to the National Press Club in Washington, D.C. and then on Capitol Hill the next day.

Some highlights:

• Of the more than 17,000 employees who have left the IRS since 2010, around 7,000 were key enforcement personnel. These are the people who audit returns, collect taxes and investigate tax-related crimes.

• Revenue officers are among the hardest hit within IRS' enforcement ranks. These are the people who collect back taxes and their number is down to only around 3,500.

  Koskinen noted that's a 50 percent drop from the revenue agent staffing level 20 years ago and it's 38 percent below 1956's level. "That's a stunning number, given the size and complexity of our economy and the tax system today," said the commissioner.

Why enforcement is important: Koskinen acknowledges that some folks might consider it good news that the IRS now has substantially fewer employees dedicated to tax collection and audits.

It's not, said the commissioner, both in real dollars and the overall survival of our tax system, which pays for all our government services.

People who are trying to follow tax laws and file and pay their returns accurately need to be confident that the system is fair and everyone is doing the same. "I'm paying my fair share of taxes, but I see others who don't and get away with it, I'll be a lot less motivated to be tax compliant in the future," according to Koskinen.

That concern is compounded when, in addition to not having enough people to enforce the tax laws, the IRS also doesn't have enough staff to help those who are trying to properly do their tax duties.

And that puts the ability of the government to fund itself in danger.

"A one-percent drop in the compliance rate translates into a loss of more than $30 billion in revenue a year," Koskinen said. "Think about what a loss of $300 billion over 10 years would mean to the federal deficit. And if the notion takes hold that the tax system is unfair, reversing that notion — and that decline in the compliance rate — won’t be easy to do."

You also might find these items of interest:

• If IRS asks, you've got some 'splaining to do
• Don't ignore that IRS letter and 9 other tax notice tips
• Selfies used as tax claim documentation, audit defense