Are you a likely tax audit target? Sequester just might save you

Kay Bell for Don't Mess With Taxes writes: You'd think judging by the size of the check I had to write the U.S. Treasury this year, my tax audit risk would be zero.

But, according to my tax software, there's still a tiny bit of a chance that the Internal Revenue Service might have some questions about my 2012 filing.

The likely reason is that I'm anindependent contractor. So one of the attachments to my Form 1040 is Schedule C. 

In many cases, at least some of the income that is entered on the Profit or Loss From Business form isn't verified by a corresponding third-party document such as a 1099-MISC. So the IRS must trust the earnings amounts, as well as the deductions, that we sole proprietors enter on Schedule C. 

And the agency has made it clear that it doesn't really want to take our word for it. The IRS believes that Schedule C filers are major contributors to the tax gap, meaning tax personnel look more closely at these filings. Consider yourself warned.

Also, I work from home and I claim a home office deduction. That's not as big an audit red flag as it once was, but it's still another item that could be fudged.

Plus, the hubby and I itemize and we were able to swing an unusually large charitable contribution, and deduction, this year.

So IRS processors might take a little extra time with our 2012 return.

But I'm hopeful that the audit risk meter is right. I'm also banking on the fact that our itemized deductions fell within the average ranges for our income level.

What's the DIF? These average deduction amounts are officially known as the Discriminate Information Function, or DIF, that the IRS uses as a first cut in deciding whether to look more closely at a return.

Each tax return is compared to a computer model and is given a DIF score rating the probability that it contains inaccurate information. Essentially, if your return's itemized claims vary greatly from those of your fellow taxpayers, you're probably going to be asked to explain why.

Returns that earn a high DIF score are pulled and reviewed by actual IRS employees who decide whether substantial additional taxes can be collected, or at least assessed.

The IRS acknowledges the existence of the DIF system, but it won't disclose the actual numbers. The tax information publisher CCH, however, crunches numbers to come up with its own DIF version. The figures below are based on 2010 IRS data; remember, it takes a while for the agency to accumulate complete figures.

Source: Wolters Kluwer, CCH

CCH notes that these figures are for illustrative purposes only. But they can give you an idea of where you might stand in the great tax audit possibility line.

And even if your Schedule A claims are a bit off, don't freak out. If your deduction is legitimate, take it. Just make sure you have the documentation to back it up.

So how do your numbers match up with CCH's estimates?

Sequester could limit audits: If you're now a bit concern that you might be hearing from an IRS examiner, you might have an unexpected anti-audit ally.

Yep, I'm talking the sequester.

The Transactional Records Access Clearinghouse says that IRS audit rates already are down substantially in 2013, and that's without taking into account the effect of sequestration.

When furloughs close IRS doors for five, and maybe seven, days this summer, some of the work that won't get done is audits.

That's the assessment of both the acting and a former IRS commissioner.

"Without a change in the current budget environment, the American people will see erosion in our ability to serve them, and the federal government will see fewer receipts from our enforcement activities," Acting IRS Commissioner Steven T. Miller testified April 9 before the House Appropriations Subcommittee on Financial Services and General Government.

Just in case you're not clear, "fewer receipts from our enforcement activities" means fewer audits.

Former IRS Commission Mark Everson confirmed that.

"Of course this has an impact on the number of audits," Everson told CNN Money. "If you have someone working on 20 audits, if they're not working as many days it's going to take longer to finish those and they're not starting new ones."

And that's the ultimate Catch-22. Sequester cuts spending. But by cutting IRS spending, it reduces the amount of money that the federal tax collector could be bringing in.

Thanks, again, Congress for nothing.