Preparing Your Tax Return to Avoid Getting an IRS Review Letter
The Internal Revenue Service has a computer program known as the Discriminant Inventory Function System (DIF). It acts as a something of a watchdog to detect fraudulent tax returns that are filed. You'll receive an IRS review letter if DIF flags yours for any reason.
Receiving such a letter from the IRS will cause at least a moment of panic even if the reason you've been flagged is innocent. Maybe you transposed a couple of digits in a Social Security number. But you could face a full-blown audit if the reason you're flagged isn't so innocent. Double-checking your return before you submit it can help you avoid being flagged.
How the Computer System Works
DIF scans tax returns based on how the IRS thinks your return should look. DIF assigns a score to each tax return received based on the likelihood that further review will result in a change to that return. It effectively flags them for further scrutiny by an agent if it detects anything amiss, and the computer will automatically send you a letter as well.
A high score isn't better in this case. A high score will almost certainly trigger a closer look from the IRS.
What the IRS Looks For
DIF flags some items for obvious reasons, such as a failure to report the income from all your Forms W-2s and 1099s. The IRS receives copies of these from the issuers as well, so the computer system knows how many and how much income should be attributable to your Social Security number. It will throw a flag if the reported figures don't match up.
The DIF software also scans Social Security numbers. If a number appears on two separate returns—which would happen if two taxpayers claimed the same person as a dependent—DIF will sound an alert.
Both taxpayers would typically receive a computer-generated letter known as a CP87A Notice if they each claimed the same dependent. You can either remove all the dependent-related tax breaks from your return when you receive this notice, or the IRS will initiate an audit so you can produce proof that you do indeed have the right to claim that dependent.
The IRS program delves also scans information on returns looking for what the IRS considers to be the most common abuses of tax law. DIF will flag your return if one or more of your deductions differs from that claimed by most other people in your same economic circumstances. You'll receive a letter and your return will be examined by an agent.
This type of alert could happen if you claim $40,000 in charitable donations when you only earn $45,000. Most taxpayers don't give away almost 90% of their incomes.
The IRS Computer Runs on Auto-Pilot
All this results in the sending of literally millions of notices—yes, millions. The notices and letters are sent automatically, initiated by the computer program, and some lack IRS contact information. They simply notify taxpayers that their refunds have been frozen, that deductions have been disallowed, or that the IRS will be requesting additional information to verify the return.
How to Protect Yourself
Mistakes happen, so be alert, particularly if yours is a complicated return. Review your completed Form 1040 with an eye for every detail—not just once, but at least twice.
Tax preparation software can help. The software will almost invariably get the important issues right if you take your time, study the accompanying tutorial, and answer all the program's questions honestly and properly. These tax preparation solutions know what you can claim based on the information you've provided and what you cannot claim.
Using a tax professional is probably the most effective safeguard.
Make sure you can substantiate all the deductions you're claiming, particularly if you decide to handle your return yourself without the help of software or a professional. You should have proof of all that you spent. Make sure you understand any and all tax credits you've claimed, and be sure you really do qualify for them.
Double-Check Those 1099 Forms
Check that you've accounted for all your tax documents—every W-2 and every 1099. You can receive 1099s for interest or dividend income, or if you're self-employed and did work as an independent contractor. Were you paid by any entity that failed to send you a corresponding tax document for that income after the first of the year? Contact that company or entity and find out why.
Companies aren't required to send out 1099-MISC forms if they paid you less than $600, but you still have to report that income on your return.
Notably, 1099-MISC forms are often issued in the name of an independent contractor instead of their business entity. You might not have alerted the clients you work with if you've incorporated recently, so you'll receive a 1099 under your own Social Security number rather than the corporation's tax ID number.
Check the names on those forms so that you can be sure which entity—you or your corporation—must claim the corresponding income, or contact your client and ask for an updated, correct form.
The Final Step
You should still make sure you haven't made any of the most common, simpler mistakes after you've checked, double-checked, and triple-checked your return. The IRS circulates a Checklist of Common Errors When Preparing Your Tax Return that you can review for any possible missteps you might have made.
Note: Tax laws change periodically and the above information may not reflect the most recent changes. Please consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and it is not a substitute for tax advice.
IRS Fact Sheet. "The Examination (Audit) Process." Page 2. Accessed July 4, 2020.
IRS. "Publication 556 (09/2013), Examination of Returns, Appeal Rights, and Claims for Refund." Accessed July 4, 2020.
IRS. "What To Do When Someone Fraudulently Claims Your Dependent." Accessed July 4, 2020.
IRS. "Do's and Don’ts for Taxpayers Who Get a Letter from the IRS." Accessed July 4, 2020.
IRS. "About Form 1099-MISC, Miscellaneous Income." Accessed July 4, 2020.