Understanding the difference between an IRS audit and a routine tax return review can help taxpayers better navigate IRS correspondence. According to the 2024 IRS Data Book, the agency closed roughly 500,000 audits across all return types while processing well over 150 million individual returns, meaning well under 1% of individual returns face a formal IRS audit each year.
Despite these low audit rates, the IRS routinely reviews returns for errors, mismatches, and questionable claims through automated systems. These reviews lead to IRS contact far more frequently than formal audit statistics suggest, making it important for taxpayers to understand the review process and how to respond appropriately.
How the IRS Selects Returns for Review
Most tax returns never receive human scrutiny. The IRS relies heavily on automated systems that scan returns, compare them to statistical norms for similarly situated taxpayers, and match reported information against data received from third parties such as employers, banks, and brokers.
Additionally, advances in analytics and automation mean returns can be flagged even without appearing suspicious. If reported income doesn’t match a W-2 or 1099 form, if deductions fall outside expected ranges, or if a credit is claimed when requirements don’t appear to be met, the return can easily rise to the top of the review queue.
Being flagged doesn’t necessarily mean the IRS believes wrongdoing occurred. It simply means the return stood out enough to merit follow-up. While a small number of returns are selected at random, most IRS contacts begin because something doesn’t align with expected patterns.
Understanding Error Notices Versus Formal Audits
What happens after a return is flagged depends on the type of issue identified. In many cases, the IRS believes it has found a straightforward error involving income reported by a third party but omitted from the tax return, or a deduction that exceeds statutory limits.
In these situations, the IRS typically sends a notice proposing a correction and explaining how it calculated additional tax. These math notices allow taxpayers to agree, respond with clarification, or dispute the adjustment. If there’s no response, the IRS can assess the tax without opening a formal audit.
However, other issues cannot be resolved automatically. Deductions, credits, or positions that depend on specific facts—such as whether an expense was truly business-related or whether someone qualified for a benefit—usually require explanation and documentation. When the IRS needs proof rather than simple math verification, it can open a formal audit.
Different Types of IRS Audits Explained
An audit is a formal review of a tax return. According to the IRS Data Book, just over three-quarters of audits are correspondence audits, handled entirely by mail. These typically focus on one or two specific items and request supporting documentation from the taxpayer.
Meanwhile, the remaining audits are conducted in person. Office audits involve meeting with an IRS examiner at a local IRS office, while field audits involve an IRS agent visiting a taxpayer’s home or place of business to review records. Field audits are generally reserved for businesses, high-income taxpayers, or situations involving extensive documentation.
The audit format usually reflects how much work the IRS expects the review to require, not necessarily the severity of suspected problems. Simple issues can be reviewed through correspondence, while returns involving businesses, multiple income sources, or significant deductions often require discussion and follow-up.
Why Taking Chances With Tax Returns Can Backfire
While formal audits remain rare, easy-to-prove mistakes are common enforcement targets. With increasingly sophisticated matching systems and algorithms, intentionally omitting income or claiming deductions without meeting requirements is more likely to attract attention than in the past.
This is especially true for tax breaks based on specific types of income, such as temporary deductions tied to tips or overtime. The IRS can easily compare these claims to reported wages and industry norms. Even if an issue never becomes a full audit, responding to notices, finding records, or hiring professional help to correct mistakes can be expensive and time-consuming.
In many cases, the cost of fixing problems far exceeds the initial tax benefit. For example, a taxpayer who incorrectly claims a $12,500 overtime deduction might save $2,577.50 initially but could face penalties and interest totaling significantly more when the IRS discovers the error years later.
The Financial Impact of Tax Penalties
When the IRS identifies an improper deduction, penalties and interest quickly accumulate. The underpayment interest rate for individuals is 7% per year, compounded daily, while the failure-to-pay penalty is 0.5% per month starting after the return’s due date.
The most common penalty involves a 20% charge under section 6662 for negligence or substantial understatement. If the IRS determines the omission was intentional, taxpayers could face a 75% civil fraud penalty under section 6663, the most severe civil penalty the agency can impose short of alleging criminal behavior.
In the overtime deduction example, what started as a $2,577.50 tax savings could ultimately cost anywhere from $2,912.58 to $4,691 depending on which penalties apply. These figures don’t include the expense of hiring tax professionals or the risk of further scrutiny in subsequent tax years.
How to Respond to IRS Notices
If the IRS sends a notice, the most important step is to respond promptly. Reading the notice carefully and focusing on exactly what the IRS is asking for can prevent minor issues from escalating into major problems.
If the IRS proposes a change based on information it already has, responding quickly can often resolve the issue without further action. If the letter indicates an audit has begun, gathering organized, relevant documentation is essential. Tax professionals generally advise providing the IRS exactly what they request without volunteering additional information that might raise new questions.
Returns involving businesses, multiple income streams, or disputed eligibility issues can become complicated quickly. Seeking professional guidance early can reduce stress and prevent small issues from becoming expensive ones, particularly when dealing with complex tax situations or significant dollar amounts.
Most IRS contact with taxpayers never escalates to a formal audit, with many issues handled through automated notices and proposed adjustments. However, low audit rates don’t protect returns with easily detectable problems, making accuracy and prompt responses more effective risk management strategies than simply relying on favorable odds.
