Preparing Your Tax Return to Avoid Getting an IRS Review Letter

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The Internal Revenue Service has a computer program, the Discriminant Inventory Function System (DIF), that acts as a watchdog to detect fraudulent tax returns when they're filed. You'll receive an IRS letter if DIF flags your return for review for any reason.

It's possible that you simply transposed a couple of digits in a Social Security number, and the number you entered belongs to someone else. 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 by DIF.

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 with DIF. It 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 Form W-2s and 1099s. The IRS receives copies of these forms from the issuers as well, so the computer system knows how much income should be attributable to your Social Security number each year. DIF will throw a flag if the reported figures don't match up.

The DIF software also scans Social Security numbers. It will sound an alert if a number appears on two separate returns—which would happen if two taxpayers claimed the same person as a dependent.

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 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.

An abuse alert could happen if you claim $40,000 in charitable donations when you only earn $45,000 because most taxpayers don't give away almost 90% of their incomes.

The IRS Computer Runs on Auto-Pilot

All this results in the IRS sending literally millions—yes, millions—of notices each year. The notices and letters are issued automatically, initiated by the computer, and some might 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. 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 against receiving an IRS notice.

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 and claimed as tax deductions. 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 Form 1099. You can receive 1099s for interest or dividend income, or if you're self-employed and did work as an independent contractor, even if it's just a side gig.

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 to find out why the IRS received a notice, but you didn't.

Companies aren't required to send out 1099-NEC forms if they pay you less than $600 a year as an independent contractor, but you still have to report this income on your tax return, even if it's less than this threshold.

Form 1099-NEC is often issued in the name of an independent contractor rather than their business entity, if they even have one. You might not have alerted the clients you work with if you've incorporated recently, so you'll receive a 1099 under your Social Security number rather than the corporation's tax ID number.

Check the names on these forms so you can be sure which entity—you or your corporation—must claim the corresponding income. You can also contact your client and ask for an updated, correct form.

The Final Step

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 provides a Checklist of Common Errors When Preparing Your Tax Return that you can review for any possible missteps you might have made.

Key Takeaways

  • The IRS uses a software program called the Discriminant Inventory Function System (DIF) to scan tax returns for fraud.
  • The DIF flags a number of conspicuous issues, such as missing W-2 income, duplicate Social Security numbers, and excessive charitable donations.
  • Hiring a tax professional, using tax prep software, and triple-checking your returns, are all ways to minimize your chance of getting an alert letter from the IRS.

Frequently Asked Questions (FAQs)

What if I'm audited and haven't kept my receipts?

You'll need to prove that the deductions you claimed were valid, so if you don't have receipts, you can recreate evidence of business expenses, medical expenses, or any other relevant figures through other means. This may look like a paper trail of deliveries, scheduling notes, or other ways to back up your claims of what happened that tax year. A tax professional can help you with your specific circumstances.

How common is it to get audited?

Audit rates vary from year to year and have been on a downward trend in the last decade. In 2020, just over 500,000 taxpayers were audited, down from 1.5 million in 2010. Your chances of being randomly audited are relatively low, but they increase significantly if your tax return has any red flags.

What should I do if I made a mistake on my tax return but I already filed?

Don't panic. Mistakes happen, and the IRS allows you to fix them. You can use Form 1040-X to amend a previously-filed return and offer an explanation of what went wrong.

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