Legal Definitions - DIF system

DIF System

The DIF system, also known as the discriminant function, is a method used by the IRS to select tax returns for auditing. This method involves using a computer program to identify returns that have a high probability of errors, such as those with a disproportionate amount of deductible expenses. The selected returns are then manually reviewed by examiners to determine which ones should be audited.

For example, if a taxpayer claims a large amount of deductions for charitable donations, but their income does not support such a high amount, the DIF system may flag their return for review. Another example could be a business that reports a significant loss for several years in a row, which may trigger the DIF system to select their return for auditing.

These examples illustrate how the DIF system is used to identify tax returns that may have errors or discrepancies that require further examination by the IRS.