When a 1099-R you receive is not reported on your original tax return, the IRS may conduct an audit, but this is not always a standard procedure performed in every such instance. There are several methods the IRS may use when selecting a return for audit, but in many cases, the IRS uses alternate methods to resolve missing income documents on your return rather than perform automatic examinations. However, you may find it beneficial to correct missing 1099-R issues as soon as you notice the omission by filing an amended return.
Types of Audits
The IRS used to use three different methods to select returns for audit. These included random selection, document matching and related examination. Under the random method, an IRS agent would randomly select your return for audit either by completely random selection, or randomly based on records that show your forms and returns often contain more errors and omissions than those of other taxpayers. Document-match selection involved the selection of a return for exam based on the omission of income documents, such as W-2s and 1099 forms. Finally, if you were already being audited for a different tax year, also known as related exam selection, the IRS agent might have selected another tax year to audit as well, such as a return from a previous or current year.
Now, the IRS chooses returns to audit based on computational scoring and an index formula. The Discriminant Inventory Function System or DIF, assigns each taxpayer a numeric score. If one of your returns receives a high score from the DIF, it is likely the return could be selected for auditing. The IRS also uses the Unreported Income Discriminant Index Formula, or UI DIF, to determine the likelihood of a return containing inaccurate information or omitted revenue. How well your return fares with these two tools determines whether or not you're audited.
The IRS may also automatically recalculate your tax return, instead of performing an audit, if you forget to include a 1099-R when you file. The IRS receives information from other parties describing the income you receive during the year, such as retirement plan distributions reported on a 1099-R. If the documents received do not match the income you reported, the IRS will calculate how including the missing income impacts your income and tax due.
The IRS will send you a CP 2000 notice when an automatic calculation occurs. This notice lists the adjustments and changes proposed by the IRS, including any tax or refund that may be due if you agree to the automatic recalculations. You must respond to this notice if you do not agree, or the IRS adjustments will take effect.
If you forget to report a 1099-R form on your return, it is best to submit an amended return to correct the error, especially if you might be exempt from paying tax on a distribution or exempt from paying a penalty for withdrawing from your plan too early before age 59 1/2. You may be exempt from paying tax on the distribution if you withdraw your contributions from a traditional IRA or Roth plan, or if you rolled over funds you received in the distribution to another retirement plan within 60 days from the date of distribution.
You might also be exempt from paying income tax on distributions you receive as a beneficiary of a deceased account holder, or while you are considered disabled. If your distribution is taxable and you withdraw early, you may be exempt from the 10 percent early withdrawal penalty if you receive the money as part of a series of periodic payments and you have separated from your employer, or if you use the money for eligible expenses, such as a down payment on a first-time home purchase, for higher education costs or for medical expenses while you are unemployed.
Amending Your Return
If the IRS performs an automatic recalculation of your taxes to include the missing 1099-R, you can either agree to the IRS proposed changes or submit an amended return to include the 1099-R and any adjustments you calculate instead. If you qualify for an exemption from tax for the 1099-R, or an exemption from an early distribution penalty, then it is to your advantage to submit an amended return, rather than agree to the automatic adjustments of the IRS.
To submit an amended return, you must prepare Form 1040X, include the 1099-R and explain any adjustments you calculate based on your scenario. Amended returns must be mailed to the IRS and cannot be e-filed. Expect the IRS to take 8-12 weeks on average to process your amended return.