Does the IRS Check Every Tax Return?

While the Internal Revenue Service (IRS) processes every tax return submitted, it does not manually review or audit each one. The agency handles hundreds of millions of returns annually, making a human inspection of every document impossible. Instead, the IRS employs a multi-layered system that begins with a universal electronic screening and progresses to targeted human examinations for a small fraction of returns.

The Initial Electronic Review

Every tax return filed first passes through a computerized system for an initial check. This automated process has two primary functions. The first is mathematical verification, where the system scans for arithmetic errors. E-filed returns have a much lower error rate—around 0.5% compared to 21% for paper returns—because tax software performs these calculations. If a math error is found, the IRS will correct it and send a notice detailing the change.

The second function is information matching. The IRS Automated Underreporter (AUR) system compares the income reported on your return against information from third parties, like a Form W-2 from an employer or a Form 1099 from a bank. If the AUR system detects a mismatch, such as reporting $50,000 in income when your W-2 shows $55,000, it flags the return.

This discrepancy results in an automated letter, most commonly a CP2000 notice. A CP2000 is not a formal audit; it is a computer-generated proposal to adjust your return based on the mismatched information. The notice identifies the source of the conflicting data and proposes a change to your tax owed, which you can either accept or dispute with documentation.

How the IRS Selects Returns for Further Scrutiny

Returns that clear the initial electronic review may still be selected for a more detailed examination. The primary tool for this is the Discriminant Information Function (DIF) system, a program that assigns a numeric score to every individual tax return. This score represents the statistical probability that the return contains errors that would change the tax liability if audited.

The DIF model is built using data from the National Research Program (NRP), where the IRS audits a random sample of returns to gather data on compliance. This data helps establish norms for deductions and income levels across different professions. A return that deviates significantly from these norms will receive a higher DIF score, increasing its likelihood of being flagged for review.

While a high DIF score is the most common reason a return is selected, it is not the only one. Some returns are chosen through random selection for the NRP. Another method involves examinations related to other taxpayers. If a business partner or ex-spouse is audited, your return may be pulled for review to ensure consistency.

Common Tax Return Red Flags

Certain items on a tax return are more likely to result in a high DIF score and attract IRS attention due to their potential for error or exaggeration. Common red flags include:

• Reporting a very high income. Incomes over $1 million statistically increase the chance of an audit, as the IRS focuses resources where potential tax adjustments are largest.
• Claiming consistent business losses. Reporting losses on a Schedule C year after year may lead the IRS to question whether the operation is a genuine business or a hobby, for which loss deductions are limited.
• Claiming unusually large deductions. The size of deductions for items like charitable contributions or business expenses relative to your income is a factor. Anything that appears excessive may warrant a closer look.
• Claiming 100% business use of a vehicle. The IRS finds it unlikely that a vehicle is never used for personal trips, making this a frequent red flag.
• Taking the home office deduction. This deduction is a focus area because there are strict rules that must be met, such as the space being used exclusively and regularly for business.
• Using round numbers for deductions. Using figures like $5,000 for supplies instead of an exact amount like $4,987.55 can signal to the IRS that you are estimating rather than using actual records.

Types of IRS Audits

If your return is selected for examination, the process can take one of several forms, varying in scope and intensity.

Correspondence Audit

The most common type is the correspondence audit, which is conducted entirely by mail. The IRS will send a letter requesting documentation to verify a specific item on your return, such as charitable donations or medical expenses. The taxpayer mails back the requested records, and the matter is typically resolved without in-person contact.

Office Audit

A more involved examination is the office audit, where you must visit a local IRS office at a scheduled time. The notice will specify the issues under review and list the documents you need to bring, such as bank statements or receipts. Office audits are generally limited to a few specific areas of the tax return.

Field Audit

The most in-depth examination is the field audit. An IRS revenue agent will visit the taxpayer’s home, place of business, or accountant’s office to conduct a broad review of financial records. This type of audit is the least common and is typically reserved for more complex returns or situations where the IRS suspects significant errors or non-compliance.