Filing taxes can be stressful and when the IRS opts to take a closer look at your return, that can only increase your anxiety level. Getting your return flagged for review doesn’t mean you’ll be audited, but it can raise the odds that Uncle Sam will discover that the numbers don’t add up. With tax season in full swing, it helps to understand why returns are flagged and what reviews involve.
How Tax Returns Are Selected for Review
While most returns are accepted as filed, some are selected for examination. The IRS examines some federal tax returns to determine if income, expenses, and credits are being reported accurately. The IRS selects returns for examination using various methods which include random sampling, computerized screening, and comparison of information received by the IRS such as Forms W-2 and 1099. Having your return selected for examination does not suggest that you made an error or were dishonest.
While a small percentage of tax returns are chosen at random for closer scrutiny, the majority of tax filers who pop up on the IRS’s radar do so because of something called the Discriminant Function System (or DIF) score. This is a computerized scoring system that evaluates your return to determine whether some changes need to be made. A second model, the Unreported Income DIF (or UIDIF) score, rates your return for the possibility that there’s income that wasn’t reported.
Returns that are assigned a high DIF or UIDIF score are more likely to be pulled aside for review. Examples of things that could trigger a higher score include having a substantially higher or lower amount of reported income compared to the previous year, claiming excessive deductions for business expenses or leaving a 1099 form off your return.
What a Review Involves
If the IRS decides that your return merits a second glance, you’ll be issued a CP05 Notice. This notice lets you know that your return is being reviewed to verify any or all of the following:
- Your income
- Your tax withholding
- Tax credits you claimed on your return
- The withholding claimed on your Social Security benefits
- Schedule C income
- Claims for household help
At this point, you’re not expected to do anything. The IRS will attempt to verify whatever information triggered the review but in the meantime, you won’t be issued a refund if you’re expecting one. If you owe taxes, you’ll still need to pay by the filing deadline to avoid a penalty.
How long the review process takes depends on what information the IRS needs to verify. If you don’t hear anything within 45 days from the date of the initial notice, however, you can follow up to see what happened to your refund.
Potential Outcomes of a Tax Review
There are several different scenarios that can play out when your tax return is flagged. The best thing you can do is hope for the best and plan for the worst. Obviously, the best outcome would be for the IRS to find that all of your information is correct and process your refund.
The IRS could verify your information and determine that you owe more in taxes. If it’s a difference of only a few hundred dollars, that may not be problematic. But if it’s several thousand dollars, you could find yourself in a financial bind. Applying for an IRS installment agreement can give you time to pay it off, but you’ll be stuck paying penalties and interest until the balance is wiped out.
Finally, there’s the chance that the initial review could lead to a full-scale audit. In that case, the IRS would look at every aspect of your return to determine whether you’ve reported your income properly and paid the appropriate amount of tax. The IRS can go back through three years’ worth of returns, or up to six years if they find a serious error.
The Bottom Line
When it comes to the IRS, playing it straight and keeping a low profile is best. If you get selected for review, the key is to not panic. If you’re worried about the possibility of an audit, getting all of your income statements, receipts and other tax-related documents organized during the review process can save you some time and headaches.