How the IRS Reviews Your Tax Return: Should You Be Worried?
With the deadline to file your taxes officially looming - get those puppies mailed or e-filed by midnight on Monday, April 18th - I’ve been getting a lot of questions around what to include on a federal tax return that seem better answered by explaining the process the Internal Revenue Service (IRS) uses to review your return. As dry as taxes may seem, it’s always a good thing to understand what the IRS is looking for and how they go about reviewing your return.
The Matchmaker & Mathematician
Once you’ve finally completed your annual civic duty of filing your tax return (You did it! Time for a glass of wine!), it’s then the IRS’s turn to return the favor. The first review that your tax return will receive is a standard automated review. A computer will check to ensure two things. First, it will look at your return and ensure that the math is done correctly. If it finds an error with the math it can immediately send you a request to pay any tax it calculates in addition to what you had previously reported. At that point you would need to protest the claim, but given that most returns are processed online today, mathematical errors are less and less likely to occur.
The second check that the computer will perform is the one I tend to get questions about. It’s essentially a matchmaking program that will take any Form W-2’s, Form 1099’s, etc. and match what is reported on your tax return to what your employer, banking institution, or another entity may have submitted to the IRS. Be assured that if you received one of these forms, the IRS also should have received a copy from the originating company specifically for the purpose of this matching exercise. Once this program runs, if there is a discrepancy between in the match, the IRS will issue a CP2000 notice to you. DO NOT PANIC! This is not an audit, it simply means that not everything matched, so read your notice carefully and look back at your files. It could be something as simple as missing a 1099, or your banking institution may have marked something incorrectly. Either way, with a little detective work on your part, there’s probably a reasonable explanation.
The Auditor
If the IRS decides to audit your return they will notify you and likely request additional documentation. This information may include things like canceled checks and banking statements. One common audit issue that comes up for individual taxpayers is the use of a home office. If you have a home office, a portion of it can be deducted on your federal taxes, however, you will need to show proof of utility bills and payments if you are audited on the issue. Remember to keep track of these as part of your business paperwork and try to limit the use of your home office to exclusively work purposes. If you are also using your office as a guest room for you in-laws, chances are that the IRS will not look at the deduction favorably.
Once the IRS has collected the information it needs from you, they will calculate if you owe any taxes in addition to what you have already payed and either solicit a payment from you or issue you a refund. At this time you have a couple options including agreeing to and paying the difference, going through the IRS Appeals division to contest the deficiency, or challenging the decision of the IRS in court. If you choose to challenge the IRS this would be a good time to reach out to an accountant or a lawyer that can help you with this matter.
The Accountant & The Advocate
If you are dealing with an audit and need some extra help, or just moral support, there are a few people that can help you. Your local tax professionals are your first line of defense. Reach out to a recommended Certified Public Accountant (CPA), Enrolled Agent (EA), or lawyer. Each of these professionals is authorized to represent you in front of the IRS and can help you understand what your options are and how to best proceed.
On the other side of the spectrum, there is a free taxpayer advocate service that the IRS provides. They can be helpful from the standpoint of gathering information and opening a dialog with the IRS when you are having trouble getting answers to your questions. This is considered an independent branch of the IRS whose mission is really to assist you and help you “understand your rights as a taxpayer”. The only issue with this service, is that budget cuts have severely limited the amount of advocates they are able to employ so your wait time to talk to a representative may be significant.
Timing is Everything
When it comes to dealing with the IRS, do not put off responding to a notice. Your tax issues will not go away and by ignoring their notices, you will do damage to any goodwill the IRS may have felt towards you and your situation. Dealing with the IRS in a timely manner is the best thing you can do to help your situation. They are trained to assess the correct amount of tax and are not “out to get you”. By responding reasonably within the time allotted by any notice you may receive, the situation may be better than you expected. You may even end up with a refund!
Written By: Lindsay Dell Cook
Lindsay Dell Cook is a CPA, writer, and founder of Budget Babble. She lives in Philadelphia with her uber supportive husband, and enjoys taking their adorable mutt for walks or reading a good book while buried under a pile of cats.