Audits, underreported income, and the IRS’s automated toolkit

It’s common knowledge now that the overall number of tax audits is down due to IRS budget cuts. We noted that fact last month, in our March 22 post on business tax audits. Audits of individuals are down as well, as the IRS deals with the budget cuts it has experienced in recent years.

Tax audits can still be a challenging issue, however, in many particular cases. In this post, let’s look at two ways other than an in-person audit that the IRS can check up on your tax compliance.

One is by document-matching of informational returns, which may result in an automated notice of underreported income. Another is a correspondence audit (audit by mail).

Notice of Underreported Income

Third parties such as employers and banks don’t only send information to taxpayers about payments made. They are also generally required to send this information to the IRS on informational returns, such as a 1099 or W-2.

And the IRS has computers that match the income you report on your tax return to the income reported reported by others on information returns.

If there appears to be a significant discrepancy, a notice of underreported income gets automatically generated. This notice is also called a CP2000 notice.

Getting such a notice doesn’t necessary mean the IRS is right about possible underreporting of income. But as we will discuss in an upcoming post, you will need to respond to the notice.

Correspondence audits

A correspondence audit is an audit conducted by mail. It is sometimes called a “corr exam.”

Like underreported income notices, the correspondence audit process is heavily automated. In recent years, the IRS has come to rely heavily on correspondence audits, which are much cheaper to conduct than an in-person (field) audit.

Responding to a correspondence audit may merely be a matter of sending additional information to the IRS. For example, you may need to provide documentation for a certain tax credit or deduction.

It is always possible, however, that serious concerns will come to light or that something will go wrong with the corr exam process. The National Taxpayer Advocate has therefore been a vocal critic of the IRS’s reliance on corr exams, which often result in deficiency notices against taxpayers who fail to respond.

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