It may not surprise anyone that the IRS has developed a software application to help them identify people that may be cheating on their taxes. According to some, this program has indicated that small businesses have a tendency to cheat on their taxes at a higher rate than most. Many of those small businesses that end up being subjected to audits are said to be located in California.
Specifically, the data shows that these small businesses are located in the Los Angeles and San Francisco areas. The program assigns a Discriminant Inventory Function (DIF) score to each tax return. The higher the DIF score, the more probable it is that the owner of that tax return will be audited. The program tends to look for deductions that seem to be disproportionate to the total income reported on a particular return.
The data has shown that real estate companies that handle a lot of rentals and construction companies tend to have higher DIF scores. The theory is that these businesses do a lot of business in cash that ends up not being reported as income. It seems that a lot of these high DIF scores tend to be clustered in large cities or city suburbs such as those in California.
Of course, the system is not foolproof. All that it can do is identify anomalous data that raises a red flag for the IRS. There may be many of these small businesses and even individuals who become subjected to audits that have done nothing wrong. Regardless of the circumstances, it's never pleasant to deal with an audit. Having advice and assistance in dealing with the IRS may help ensure that the taxpayer does not have to pay a penny more than they actually owe.
Source: USA Today, "Tax audit chances greater in L.A., Atlanta, D.C., etc.," Stephen Ohlemacher, April 14, 2013