The Discriminant Index Function is a scoring system developed and used by the IRS. It utilizes algorithms and statistical models to analyze tax returns and assign scores based on a variety of factors. These factors can include the size of deductions, types of credits claimed, income amounts, and the comparison of these figures against relevant averages. The higher the DIF score, the higher the likelihood that auditing the tax return will result in a change to the taxpayer’s liability. 

1. Scoring Tax Returns: Every year, after tax returns are filed, the IRS processes these documents through its computer systems, where the DIF system assigns a numerical score to each return.
   
   
2. Selecting Returns for Audit: Returns with higher DIF scores are more likely to be selected for audit because these scores suggest greater discrepancies or anomalies compared to typical returns. However, a high DIF score alone does not guarantee an audit. The IRS uses other methods and criteria to select returns for an audit as well.
   
   
3. Manual Review: Selected high-scoring returns may undergo a manual review by experienced IRS staff, who will decide whether to forward the return for a comprehensive audit. 

This step ensures that not only quantitative data but also qualitative factors are considered in the final decision. Ultimately, stats are not published but a small amount actually make it through to an audit.  If the agent believes a crime has occurred they can refer to the DOJ or IRS CI.

Example 1: A taxpayer files a return reporting an income of $30,000 but claims charitable donations of $15,000. The DIF system flags this return due to the unusually high ratio of donations to income, which deviates significantly from statistical norms.

Example 2: Another return might report $100,000 in income and $25,000 in home office expenses. Since these expenses are disproportionately high, the DIF system assigns a higher score to this return, signaling potential over-reporting of deductions or under-reported income.

Example 3: A tax return for a small business reports $50,000 in revenue but $0 in expenses. This anomaly would result in a high DIF score because it's uncommon for businesses to operate without any expenses, making this return a candidate for further review.

Never EVER:

• Fail to report income = criminal
• Ensure your bookkeeping is accurate!  Bad bookkeeper = errors that lead to IRS red flags
• Do not make up deductions that do not exist.  The IRS is actually pretty smart!