Matching information
The IRS uses a computer system to match the information taxpayers provide on their returns with data from other sources: financial institutions, Social Security, the unemployment office, etc. The IRS checks 29 types of income and payments, including: wages reported by employers on Form W-2; contractors’ earnings reported by the businesses that hired them; Social Security retirement and disability benefits; unemployment, public assistance and other benefits; interest reported by banks and other financial institutions (1099 reports); mortgage interest deductions (1098 reports); state taxes paid; property and real estate taxes paid; casino and lottery winnings; and retirement distributions.
Automatic adjustments and substitute returns
The matching program is the first screen of the audit process. If the computers have caught a source of income you did not disclose, the IRS will send you a notice with a proposed adjustment (for example, a CP2000). And if you did not file a return at all, the IRS may prepare one for you itself, which is called a Substitute for Return (in its automated version – the Automated Substitute for Return, ASFR).
The IRS will send you a letter explaining the proposed adjustments, the amount of additional tax due and your rights of appeal. In response, you can pay the amount due, ask for more explanation, or submit explanations and documentation. If you do not respond within 30 days, the IRS sends a demand for payment called a Notice of Deficiency. If you disagree with the IRS’s determination, you can file a petition with the Tax Court within 90 days.
Verifying information
IRS computers check the validity of credits claimed for children: whether the Social Security numbers are genuine, whether the numbers match the children’s names, and whether the child has also been claimed as a dependent by another taxpayer.
In an effort to stamp out improper Earned Income Tax Credit (EITC) claims, the IRS checks the identity and income of all family members.
Checking the math
At the same time, the IRS computer looks for mathematical and clerical errors, such as: arithmetic mistakes, use of the wrong tax tables, entries that do not match others (for example, figures carried over incorrectly to another form or copied incorrectly from a worksheet), and deductions or credits above the set limits. When the IRS finds an error, it sends the taxpayer a letter. The taxpayer can pay the additional tax or dispute it and submit an explanation.
All tax returns go through the checks described above, regardless of whether they will be subject to further examination or not.
What is the discriminant score
Even if your tax return is correct and successfully passes through the screens above, it may still raise a red flag. That is because the computer calculates a score called DIF (from discriminant function), which can range from negative numbers up to several hundred points. The higher the DIF, the greater the likelihood of getting caught. A score in the range of 500 or 600 points may trigger an audit.
The DIF score measures how the various figures on the tax return relate to one another, as well as how similar the return is to the average figures of people in a similar financial situation. For example, a high discriminant score will go to someone who deducts charitable donations, business meals or mortgage interest that are much higher than those of families in the same tax bracket.
Economic reality
A small sole proprietorship gives the most room for tax maneuvering, not always in line with the letter of the law. The IRS knows this and, in justified cases, conducts economic reality auditing, which goes beyond checking the return itself. Tax examiners look at whether business owners’ lifestyles match their declared earnings. For example, an address, property taxes and mortgage interest may point to a lifestyle beyond what the declared income suggests. Your paperwork may be in order, but how will you explain a new Mercedes and two houses when you report income equal to half of your living expenses?
FATCA
The tax world is becoming more and more interconnected and globalized, and countries exchange financial information about their citizens under agreements related to FATCA (the Foreign Account Tax Compliance Act) and the Common Reporting Standard (CRS). Information about a taxpayer’s financial activity, for example in Poland, may be reported to the IRS by the Polish tax authorities, which I explain in detail in the book “Jak chować pieniądze przed fiskusem” (“How to Hide Money from the Taxman”).
In closing
The likelihood of a tax audit for the average person is small, but it rises with income – multimillionaires are audited most often. Many audits are conducted by mail, and the rest in person. The IRS publishes current audit statistics every year in its IRS Data Book report. Because of budget cuts, the IRS has fewer and fewer examiners, so the number of thorough audits is falling.
To stay out of trouble with the IRS, you need to blend into the crowd, that is, not have excessive deductions or expenses out of proportion to your income. This does not mean avoiding the tax breaks you are entitled to, but using them sensibly. IRS computers hunt for inconsistencies and deviations from the norm. Your accountant will surely tell you more.
Updated October 2026.
