What Does IRS Code 424 Mean and How Should You Respond?

Seeing IRS Code 424 on your tax transcript can be concerning, especially if you’re unsure what it means. This code indicates that the IRS has selected your return for further examination, which could lead to an audit or additional verification steps. While this doesn’t automatically mean there’s a problem, it does require attention.

Why Code 424 May Appear

The IRS assigns Code 424 when a return is flagged for review due to discrepancies, unusual activity, or random selection. One common reason is mismatched income reporting. If the income on your return doesn’t align with what employers, banks, or other institutions have submitted via W-2s, 1099s, or other forms, the IRS may take a closer look. This can happen if a taxpayer forgets to report freelance income, stock sales, or other taxable earnings.

Claiming deductions or credits that seem inconsistent with typical filing patterns can also trigger scrutiny. Large charitable contributions, significant business expenses, or refundable credits like the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) may prompt review if they appear disproportionate to reported income. The IRS uses automated systems to compare returns against statistical norms, flagging deviations for further examination.

Past filing history can also influence selection. If a taxpayer has been audited before and similar issues arise in a new return, the IRS may take a closer look. Returns involving businesses, rental properties, or self-employment income often receive more attention due to the complexity of deductions and the potential for underreporting.

What It Means for Your Return

When IRS Code 424 appears, your return has moved beyond routine processing and is under review. This doesn’t necessarily mean you owe additional taxes, but the IRS is examining specific aspects of your filing. Depending on the findings, this could lead to requests for more information, adjustments to reported figures, or, in some cases, a formal audit.

The timeframe for resolution varies. Some reviews are completed within weeks if the IRS can verify details internally. More complex cases, particularly those requiring taxpayer-provided documentation, can take months. If discrepancies are found, you may receive a CP2000 notice outlining differences between your filing and IRS records, proposing adjustments. This is not a formal audit but a request to reconcile inconsistencies.

If an audit is initiated, it can take different forms. A correspondence audit, the most common type, involves responding by mail. A field audit, which is less frequent, involves an in-person review at your home, business, or an IRS office. The scope of the audit depends on the complexity of the issues being examined.

Documentation the IRS May Request

When selected for review, the IRS may require supporting documents to verify reported figures. The specific records requested depend on the areas under review.

For income verification, the IRS may request pay stubs, bank statements, or brokerage account summaries to confirm reported wages, dividends, or capital gains. This is especially relevant for individuals with multiple income sources, such as independent contractors or investors. Large cash deposits or transfers between accounts may also require an explanation.

If deductions are under scrutiny, receipts, invoices, or mileage logs may be necessary. For instance, taxpayers claiming medical deductions must provide billing statements and proof of payment, while those deducting home office expenses should submit utility bills and a floor plan showing the business-use percentage of their residence. The IRS may also request lease agreements or mortgage statements if rental income or property-related deductions are involved.

Potential Adjustments to Your Account

The IRS review process can lead to changes in taxable income, deductions, or credits, which may impact your final tax liability. If discrepancies are found, adjustments may be made. For example, if a taxpayer incorrectly categorized wages as self-employment income, this could alter their tax obligation, potentially leading to additional liabilities or refunds.

Interest and penalties may also apply if underpayment is determined. Interest accrues on unpaid taxes from the original due date, compounded daily. Accuracy-related penalties can be assessed if there is a substantial understatement of income tax, typically defined as exceeding the greater of 10% of the correct tax liability or $5,000. These penalties are generally 20% of the underpayment but can be higher in cases involving fraud.

In some cases, adjustments may result in a refund if the IRS finds that a taxpayer overreported income or failed to claim eligible deductions. If a refund is due, it may be issued as a direct deposit or check, with interest included if the adjustment takes significant time to process.

Steps to Address Your Notice

Receiving notice that your return is under review requires a proactive approach. The steps you take will depend on the nature of the IRS inquiry, the documentation required, and whether adjustments have already been made.

Start by reviewing your tax transcript. By accessing your IRS account online or requesting a transcript by mail, you can identify the specific areas under review. Code 424 is often accompanied by other transaction codes, such as Code 420 (audit indicator) or Code 290 (additional tax assessment), which provide further insight into the scope of the examination. If a CP2000 notice or audit letter has been issued, carefully reviewing the IRS’s proposed changes and comparing them to your records is essential before responding.

Gather and submit supporting documents as requested. If the IRS asks for receipts for deductions or bank statements for income verification, ensure they are well-organized and clearly labeled. If discrepancies exist, providing a written explanation alongside the documentation can help clarify any misunderstandings. Be mindful of response deadlines, as failure to reply within the specified timeframe can lead to automatic adjustments or additional penalties.

If the review escalates to an audit, consulting a tax professional or enrolled agent can be beneficial, particularly if complex tax positions or large financial transactions are involved.