If you fear a tax audit every time you file, here’s a fact that may help you breathe a little easier: The Internal Revenue Service (IRS) selects less than 1 Income tax returns for audit each year.
But what you may not know is that the IRS doesn’t need to audit you in order to owe you additional taxes.
The agency’s computers are automated to scan returns and match reported income with data from employers and banks. Those scans flag anything that looks a bit off.
When something doesn’t line up, you’ll get a letter. And while it’s not technically an audit, the consequences can be costly and painful.
The IRS knows more than you think
Every January, you receive several forms for income – like W-2s from employers, 1099-INT forms for interest earned and 1099-NECs for freelance work.
What you may not realize is that the IRS often also receives copies of all of these documents before you file your return.
Once you file, IRS computers compare the earnings you report on your income tax return with the earnings reported by third parties. If there are any discrepancies, your return is flagged without any human review or official audit.
The system then generates a notice proposing additional tax based on any income you have disclosed.
Here are some common situations that may draw the attention of the IRS:
- Unreported 1099 income. Don’t forget the income from that freelance project you did or the interest you earn from a high-yield savings account. If you received a 1099 and it doesn’t include that income, expect a notice.
- W-2 Discrepancies. Sometimes employers make mistakes, or you may have had multiple jobs and missed reporting one. Either way, the IRS’s computers will catch it.
If your figures do not match what the IRS has on record, you may need to explain why.
What happens when things don’t match
When the IRS catches a discrepancy, you’ll usually receive a notice of correction. This proposed adjustment explains what the IRS believes you owe and why.
These notices explain the discrepancy, show the IRS calculations and give you options. You can agree and pay or dispute and provide documentation that shows the IRS is wrong.
If you ignore the notice completely, the IRS may assess additional tax without opening a formal audit. The agency does not require your agreement or even your participation to add charges to your account.
cost of risk
Some taxpayers believe that the low audit rate gives them scope to go beyond the limits, but automatic matching has changed the reality.
Consider failing to report freelance income.
Even if you avoid a full audit, the tax bill from the IRS rarely comes alone. As per law, the agency currently charges interest on underpayments. 7% per annumDaily aggregated – which is aggregated automatically regardless of the cause of the error.
The costs increase even more if the IRS finds you were at fault. For errors caused by negligence or disregard for tax rules, you will face an additional 20% related to accuracy Fine.
In the most serious cases where the agency establishes DangerThat penalty nearly quadruples to 75%.
Add the cost of hiring professional help to respond, the time it takes to gather records, and the stress of extended IRS correspondence. That risk becomes costly quickly.
And if you fail to take action, the IRS may issue a extortion To satisfy tax debt. This could come in the form of seized and sold cars, personal property or real estate, or the IRS may garnish wages or take money from your bank account.
How to Protect Yourself Before You File
The good news is that most IRS notices can be avoided with some basic preparation.
- Check every document. Before submitting your return, look closely at each income document you received. If you received a form, the IRS received it too. Include everything.
- Keep records that support the deductions. If you claimed business expenses, charitable donations or other itemized deductions, retain documents proving the amount and eligibility.
- Review past returns for consistency. Large changes in income or deductions from year to year may attract attention. Make sure you can explain any significant changes.
What to do if you receive a notice
Never ignore IRS correspondence. There is a fixed time limit for disputing the proposed changes.
Read the notice carefully and identify if it is a misunderstanding that can be cleared up with a brief response. If the IRS is correct, agree to it immediately to prevent additional penalties and interest from accruing.
In tricky situations, consider seeking professional help before reacting. Providing too much information or incorrect documents can sometimes create new problems.