Preparing Your Tax Return to Avoid Getting a Letter From the IRS

Green check marks on a checklist, suggesting everything is good to go

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The Internal Revenue Service (IRS) does not leave much to chance. It has a computer program called the Discriminant Inventory Function System or DIF for short, which acts as a watchdog where fraudulent tax returns are concerned. DIF scans tax returns and flags them for further scrutiny by an agent based on how the IRS thinks your tax return should look. The computer will automatically send you a letter asking for more information if this occurs.

Receiving such a letter is not a pleasant experience. Even if the reason you are flagged is relatively innocent—maybe you transposed a couple of digits in a Social Security number—a letter from the IRS will still cause a moment of panic. If the reason you are flagged is not so innocent, you could face a full-blown audit. Double-checking your tax return before you submit it can help you avoid being flagged in the first place.

What the IRS Looks For

What catches the attention of the DIF screening process? Some items are flagged for obvious reasons. A failure to report the income from all W-2s and 1099s, for example. The IRS receives copies of these from the issuers so the computer system knows how many are attributable to each Social Security number.

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 throw up a flag. The second parent to claim the child would typically be the one to receive the computer-generated letter because this is the return that triggered the computer.

But the IRS program delves deeper. It also scans information on returns looking for what the IRS considers the most common abuses of the law. If one or more of your deductions differs from that claimed by most other people in your same economic circumstances, DIF will flag your return. You will receive a letter and your return will be examined by an agent. This could happen if you claim $40,000 in charitable donations when you only earn $45,000, Most taxpayers do not give away almost 90 percent of their earnings.

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 many lack IRS contact information. They simply notify taxpayers that their refunds have been frozen, that deductions have been disallowed, or that they request 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 return with an eye for every little detail not just once, but twice.

Tax preparation software can help. If you take your time, study the accompanying tutorial, and answer all the program's questions honestly and properly, the software will almost invariably get the important issues right. These tax solutions know what you can claim based on the information provided and what you cannot. Of course, using a tax professional is probably the most effective safeguard.

If you decide to handle your tax return yourself without the help of software, make sure you can substantiate all the deductions you are claiming. You should have proof of all that you spent. For the tax credits you claimed, make sure you understand them, and be sure you really do qualify. 

Double-Check Those 1099 Forms If You Are Self-Employed

Check that you have accounted for all your tax documents, every W-2, and every 1099. Did you do work for anyone who did not send you a corresponding tax document for the income after the first of the year either as an employee or as an independent contractor? Contact that company or entity and find out why.

Notably, 1099-MISC forms are often issued in the name of an independent contractor instead of his or her business entity. If you have incorporated recently, you might not have alerted the clients you work with so you will 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

Once you've checked, double-checked, and triple-checked. You should still make sure you have not made any of the most common, simpler mistakes. The IRS circulates a Checklist of Common Errors When Preparing Your Tax Return that you can review and check for any possible missteps you 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.