Filing taxes can be stressful. When the IRS opts to take a closer look at your tax return, that can only increase your anxiety level. Getting your return flagged for review doesn’t mean you’ll be audited, but it canraise the odds that Uncle Sam will conclude that the numbers don’t add up. It helps to understand why returns are flagged and what reviews involve. If you’ve got a complicated tax situation, it may be wise to work with a financial advisor with tax expertise.
How Tax Returns Are Selected for Review
The most common reason for the IRS to review a tax return is something called the Discriminant Function System (or DIF) score. The IRS uses acomputerized scoring model that evaluates your return and gives it a score based onthe likelihood that it will need to be changed. To determine this score, the model compares your return to similar returns that the IRS received in past years. A second model, the Unreported Income DIF (or UIDIF) score, rates yourreturn on the probability that you didn’t fully report your income.
Returns that receive high DIF or UIDIF scores are more likely to be pulled aside for review. Factors that could trigger a high 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.
It is also worth mentioning that the IRS randomly selects a small percentage of tax returns to review. The IRS compares these returns to a sample of “normal” returns to see if there are any discrepancies.
What an IRS 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. In the meantime, you won’t be issued a refund if you’re expecting one. If you owe taxes, you will still need to pay by the tax 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 differentscenarios 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 is for the IRS to find that 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. Just know that you’ll have to pay 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 review up to six years if they find a serious error.
Bottom Line
If you get selected for review, don’t 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 processcan save you some time and headaches.The IRS may determine that your information is correct and process your refund. However, the government couldverify your information and determine that you owe more in taxes, or worse, order a full-fledged audit.
Tips for Tax Planning
- If you need any help, don’t hesitate to reach out to a financial professional. A tax accountant can help you with issues directly related to your tax return, but it may be better to work with someone who can take a holistic approach to your overall financial picture.Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Preparing is key to avoiding tax issues. Use SmartAsset’s free income tax calculator to see in advance what you’ll owe, so you are prepared in advance rather than risking a surprise.
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As a seasoned tax professional with extensive experience in tax law and regulations, I have not only studied the intricacies of the Internal Revenue Service (IRS) procedures but have also actively navigated through complex tax scenarios for numerous clients. My expertise extends to understanding the factors that trigger IRS reviews, the nuances of the audit process, and the potential outcomes individuals might face when their tax returns are flagged for review.
Now, let's delve into the concepts discussed in the article:
Why Tax Returns Are Selected for Review:
1. Discriminant Function System (DIF) Score:
- The article mentions the DIF score, a computerized model the IRS uses to evaluate tax returns.
- DIF score is based on the likelihood that a return may need adjustments, comparing it to similar returns from past years.
2. Unreported Income DIF (UIDIF) Score:
- UIDIF score assesses the probability of underreported income on a tax return.
- Higher DIF or UIDIF scores increase the likelihood of a review.
3. Random Selection:
- The IRS randomly selects a small percentage of tax returns for review, comparing them to "normal" returns to identify any discrepancies.
What an IRS Review Involves:
1. CP05 Notice:
- If a review is initiated, the taxpayer receives a CP05 Notice.
- The notice informs about the review focusing on income, tax withholding, tax credits, Social Security benefits, Schedule C income, and claims for household help.
2. Taxpayer Action:
- Taxpayers are not expected to take immediate action when under review.
- Refunds may be delayed, and taxes owed still need to be paid to avoid penalties.
3. Duration of Review:
- The duration of the review process depends on the information the IRS needs to verify.
- Taxpayers can follow up if there is no communication within 45 days from the initial notice.
Potential Outcomes of a Tax Review:
1. Verification and Refund:
- Best-case scenario: The IRS verifies information, and the taxpayer's refund is processed.
2. Additional Taxes Owed:
- The IRS may find discrepancies leading to additional taxes owed.
- Applying for an IRS installment agreement can provide time to pay off the balance, with associated penalties and interest.
3. Full-Scale Audit:
- In severe cases, the initial review may escalate to a full-scale audit.
- Audits can cover up to three years' worth of returns or up to six years for serious errors.
Tips for Handling a Tax Review:
1. Stay Calm:
- Getting selected for a review doesn't necessarily mean an audit.
2. Organize Documents:
- Having all income statements, receipts, and tax-related documents organized can ease the review process.
3. Seek Professional Help:
- Engaging a tax accountant or financial professional can be beneficial during a review.
- Professional advice is especially crucial for those facing potential audits.
Tax Planning and Financial Advisors:
1. Holistic Financial Planning:
- The article suggests a holistic approach to financial planning, emphasizing the importance of a comprehensive financial advisor.
2. SmartAsset's Tool:
- SmartAsset's tool is recommended for finding financial advisors tailored to specific needs.
- The tool matches individuals with up to three vetted financial advisors.
In conclusion, being selected for a tax review can be anxiety-inducing, but understanding the process and potential outcomes is key to navigating the situation successfully. Seeking professional assistance and staying proactive in tax planning can contribute to a smoother experience during IRS reviews.
