Posted by Mike Smith :: October 16, 2007 @ 6:34 am

In her recent article, Associated Press writer Eileen Alt Powell outlined a portion of the IRS’s National Research Program that will lead to 13,000 special audits of American taxpayers this year.

The goal of these special audits is to determine ways to rein in the tax gap, which is the shortfall of tax payments that are made relative to what should be paid. IRS research from 2001 showed that even after tracking down shortfalls and assessing penalties for that year, the tax gap was still nearly $300 billion.

While the number of special audits pale in comparison to the total number of audits (1.2 million last year), they will be used to influence audit selection criteria for future years. By closely examining the small sample of taxpayers, the IRS hopes to finds trends and common occurrences that can be used to identify others with a similar likelihood of having errors on their tax returns.

Ideally, having better audit selection criteria should make the IRS more efficient in selecting which returns to audit. This should be good news for the average citizens who properly pay their taxes, as their probability of being selected for audit should decrease. The special audits may lead to changes in the tax code as well, if the source of common errors can be identified.

If you are one of those selected for special audit, you shouldn’t be as concerned as if you were selected for a normal audit. Since the special audit participants are selected randomly, you can blame bad luck for your selection rather than something suspicious in your return.

If you are selected, you may not feel much of an impact. Some special audit returns will be verified using documents that the IRS already receives from your employer, banks, etc. For example, Lending Club sends each lender a 1099 form detailing the lender’s P2P loan interest income; a copy of each form is also sent to the IRS. If the IRS’ documents match what you report, then you may not have to do anything as a special audit participant. In other cases, you may need to provide the IRS with backup documentation or even go through a more thorough review.

As with any audit, proper filing will make the process go much more smoothly. While any audit can be a stressful experience, being selected for a special audit shouldn’t be cause for concern in most cases. If you are one of those unlucky 13,000 this year, at least you’ll know what these special audits are all about.