IRS employee here. taxmankeith's write-up that Nostavalin posted is excellent, it's exactly the information you would receive if your identity theft issue was detected by or presented to an IRS employee over the phone or at a walk-in office.
I would like to add to that, and to answer your other questions.
Once your account is flagged as having ID theft involvement, you will most likely end up having your account coded to require an IP-PIN or Identity Protection PIN. This is a six-digit number that will be mailed to you usually in December and must be put on your tax return, otherwise the return will NOT post to your account. You can get more information on the IP-PIN on irs.gov.
If for whatever reason your account is not selected for the IP-PIN program, unfortunately there is very little you or we can do to prevent a fraudulent return from being filed. The only thing we can do is fix the account afterwards (which unfortunately can sometimes take quite a bit of time. I have seen it take anywhere from 3 months to a year.) The only thing that you can do is file your return as soon as you possibly can, in an attempt to beat the fraudulent return to the punch.
How it happens is difficult to say for sure, but somehow somebody gained access to your info, at the very least your name and social security number. Most of the time the address they use is fake, and the income they are claiming is also fake, they are attempting to get refunds based on fraudulent tax withholdings that don't exist and/or from tax credits based on this fake income.
As far as "damage" to you, you will not be held financially liable for any fraudulent refunds that may possibly be issued from your account. Aside from the timeframe and hassle of dealing with the tax related ID theft, the other damage they could do would involved any other non-tax related ID theft, e.g. taking out loans or credit cards in your name.
Main thing to do now is get that 2014 return filed ASAP and don't forget to attach that fully completed and signed Form 14039 "Identity Theft Affidavit" with the return. Best of luck, and hope it all works out for you.