True story: When the Internal Revenue Service added a requirement that taxpayers list the Social Security numbers of their dependent children in order to claim a popular tax credit, a funny thing happened. The number of kids listed on American tax forms plummeted from 77 million to 70 million. Now, it’s possible that aliens abducted millions of young earthlings that year, and the government is still covering it up. But I’m going with a different theory. I believe that in random audits, the IRS had caught people taking deductions for children who didn’t exist, so they changed the rules to seal that loophole.
That might explain why the IRS runs an initiative called the National Research Program, which chooses random returns to audit in order to identify what it gently refers to as “noncompliance.” There's an estimated $450 billion difference between what taxpayers owe and what they pay, and the NRP is, loosely speaking, one of three ways in which you can become an unwilling partner in the IRS’ efforts to close that tax gap. The second way to become a bogey lighting up the taxman’s radar screen is to make unforced errors on your return: bad math, getting your Social Security number wrong, not reporting income, etc. If any of these things describes you, I recommend hiring a more hands-on accountant. But when it comes to the third category, the one most likely to trip you up, I can help out.
Every red-blooded taxpaying American should know about IRS publication 556, which includes a brief mention of something called the Discriminant Inventory Function System. The DIF is a scoring system, and though the name is a mouthful, the agency’s explanation for why you should care about it is crystal clear: “If your return is selected because of a high score under the DIF system, the potential is high that an examination of your return will result in a change to your income tax liability.” And you can probably figure out which way that liability is most likely to change. So the DIF is more like golf than basketball: a low score is better. Though the exact methodology is a closely guarded secret, savvier accountants have come to learn which features of tax returns tend to act like pheromones for auditors. Here are five ways to avoid waving a red flag in front of the IRS when you file your 1040 next month.