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Benford's Law and the IRS

•  Introduction  •  Introduction (cont.)   
•  Benford's Law and the IRS  •  The Math  •  The Answers

How does this help the IRS catch tax evaders? While the IRS doesn’t reveal its techniques, Benford’s Law is something that many professionals take in to account when looking for, and proving, fraud cases. Most people making up numbers on documents such as a tax return are ignorant of Benford’s Law. As a result of their assumptions, they tend to choose numbers that begin with five and six at a much higher frequency than would naturally be found in this type of data. There are programs that scan documents and look for the numbers to follow Benford’s Law. When one doesn’t fit into Benford’s parameters, it could be flagged for further review.  Obviously there are limitations to this method. Many of our individual returns will not closely follow Benford’s Law, but when lumped together as a whole, every leading digit from every tax return filed this year should closely follow Benford.

The following table summarizes the findings of Dr. Mark Nigrini. He searched 169,662 lines of IRS model files to compile this data. The fraudulent data is from a 1995 King’s County, New York, District Attorney’s Office study of financial data for businesses that do not follow Benford’s law.

1995Benford

 

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