Filing your return may not mean the end of tax issues

  • Taxpayers are more likely to receive an IRS notice than an actual audit.
  • Budget cuts may explain the decline in audits, but the rising sophistication of algorithms means the IRS can flag your mistakes or omissions with greater ease.

Just because you file your taxes for a refund and the IRS accepts your return doesn't mean you are free and clear.

Each year, the IRS mails notices to millions of taxpayers challenging their reporting. Notices from the tax collector aren't as severe as an agency audit, yet they serve essentially the same purpose — and most likely you'll owe taxes.

"Technically, these aren't audits," said Jim Buttonow, director of H&R Block's Tax Audit and Notice Services. "But that doesn't really matter, because they feel like audits to most people."

Tax audit 1040
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Taxpayers are more likely to receive an IRS notice than an actual audit. In 2016, the IRS challenged more than 5.1 million returns, mainly for underreported income and math errors, according to an H&R Block analysis of IRS data. That compares with just over 1 million audits that year — a roughly 30 percent drop since 2011.

Budget cuts may explain the decline in audits, but the rising sophistication of algorithms means the IRS can flag mistakes, omissions and discrepancies with greater ease and efficiency in our ever-expanding world of digital paper trails, tax experts say.

"It's a little bit of Big Brother," said James Guarino, a certified public accountant and certified financial planner in Tewksbury, Massachusetts. "The government's computers have a straight-forward matching process. ... There is no place to hide."

Taxpayers can be audited or hit with a tax notice at any time of the year. The IRS letters can go out a few months after you file or as far back as three years from your filing date. Responding within 30 days is the best advice to avoid additional tax, penalty or interest.

"The government's computers have a straight-forward matching process. ... There is no place to hide." -James Guarino, CFP and accountant

If you receive an IRS notice, called a CP2000, the agency isn't accusing you of cheating or lying. Most reporting challenges involve missing information or forms as well as errors with tax-credit claims and dependent deductions. And in most instances, the IRS will want you to pay up — with penalties and interest on top.

"Don't panic. Many of these letters can be dealt with simply and painlessly,'' the IRS says on its website. "An IRS notice … will be about a specific issue. It may ask you for more information. It could also explain that you owe tax and you need to pay the amount that is due."

The IRS will give a you a fair chance to defend your reporting. If you end up owing, you may apply for some penalty relief or you can work out a payment plan with the agency, tax experts say.

Douglas Boneparth, a certified financial planner in New York, said he himself as well as some of his clients have gotten IRS notices, which he calls "love letters." He reassures clients by telling them, "it might seem scary, but don't freak out."

From his prospective, Boneparth said smaller business owners and entrepreneurs are being targeted, which usually stems from payroll issues. As for individual taxpayers, innocent miscalculations might occur because "you fat-fingered something on TurboTax."

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Receiving an audit letter, however, is a more serious matter and carries an air of suspicion. Since audits are in-depth investigations, they can be time-consuming and costly. You must prove your income, deductions and credits with the necessary paperwork.

Some taxpayers get audited because the IRS is auditing another individual with whom they did business. Most audits are handled through the mail, with about a third conducted face to face, the agency says.

Responding to an audit can cost $2,000 to $5,000 but can reach into the "tens of thousands of dollars" in extreme cases, said Guarino. If audited, his firm will charge extra to handle it — which might leave some clients feeling like they're "paying for the tax return twice."

Sometimes, there can be a silver lining: Not every IRS notice or audit leads to a negative outcome. According to IRS data, 37,000 audited returns earned a bigger refund in 2016.