Is this your situation? Just when you thought tax season was over, you receive a notice from the IRS. Don't panic -- you're not alone. The IRS sends millions of notices and letters out each year. Many are computer-generated, because these days, the IRS relies less on employees to get directly involved in issues including collections. Many state and local governments are following suit and sending out more notices to taxpayers.
Some IRS notices inform taxpayers about an impending audit. In 2013, the IRS sent 1.4 million audit notices. The chances that you'll be audited vary, depending on the types of income and deductions reported, as well as your income level. For example, the IRS audited less than 1 percent of personal tax returns with income under $200,000, compared to more than 10 percent of personal returns with income of more than $1 million.
In most cases, you can address the audit issue with relative ease, especially if you rely on a tax professional to represent your position. Although the IRS still conducts audits and face-to-face audits, its compliance strategy has shifted. Today, the IRS conducts more "correspondence" audits than "field" audits. In fiscal 2013, there were 1,060,779 correspondence audits and 344,152 field audits. By comparison, the IRS conducted 625,021 correspondence audits and 567,759 field audits in fiscal 1998.
In other words, you're much more likely to get a letter in the mail than meet with an IRS auditor. Typically, a correspondence audit is limited to one or two items on a return. These matters can often be resolved by mailing the IRS copies of receipts, checks or other records requested.
Note: Tax notices are sent to mailboxes through the U.S. Postal Service. The IRS never contacts taxpayers via telephone, e-mail, text message or social media to ask for personal or financial information. An IRS solicitation in any format other than a letter sent through the U.S. Postal Service could be a ploy to steal your personal information or access your financial records.
Making IRS notices clear and efficient is one of the agency's top priorities. Starting in 2010, the IRS began redesigning notices to look less like legal documents. The language is generally easier to understand than in the past, but it's natural to worry when you receive a notice. If you receive a notice and want more information about how to respond, contact your tax adviser right away.
More Notices, Fewer Agents
The IRS ramped up its collection efforts after a 2001 study revealed that a $345 billion "tax gap" existed between the amount owed by taxpayers and the amount the IRS actually collected. The study pinpointed a complex and ever-changing tax code that is ripe for abuse.
IRS enforcement staffing levels have decreased in recent years. In 2013, there were roughly 14 percent fewer enforcement officers and agents than in 2010. Many IRS notices are computer-generated. In fact, when you open a notice from the IRS, you might be the first human being to read it.
Many notices are routine and can be resolved with a few simple steps. For example, you may need to file an additional tax form. The IRS may have been unable to make a direct deposit for your refund and, instead, is sending a refund check. Or you might have missed a small amount of interest from a bank account. With more than 100 types of federal tax notices (see "Common IRS Notices," below), the possibilities for IRS inquiry are endless.
Case in Point: CP2000 Notices
One of the most common IRS notices is CP2000, a notice of proposed adjustment for underpayment or overpayment. Receiving one isn't always bad news -- some of these notices even propose a refund.
Here's what happens behind the scenes. IRS computers compare information reported by employers, banks, businesses and other payers on Forms W-2, 1098, and 1099 with personal information, income and deductions you report on your income tax return. If you fail to report any income, payments, or credits (or if you overstate certain deductions) on an income tax return, you may receive a CP2000 notice. It is not a bill. It informs you of the proposed adjustments to income, payments, credits or deductions. This may result in additional tax owed or a refund of taxes paid.
The IRS also compares personal information, such as the names, addresses and Social Security numbers of you, your spouse and your dependents. Inconsistencies between personal information on Forms W-2, 1098, and 1099, and your personal tax return also could result in an IRS notice.
A CP2000 notice will show the amounts you reported on your original or amended return, the amounts reported to the IRS by the payer, and the proposed adjustments by the IRS. The notice also provides the name of the payer, the payer's ID number, the type of document that was issued (such as a W-2 or 1099), and the tax identification number of the person to whom the document was issued. Based on payer documentation, the notice proposes either an increase or decrease in your tax liability. Be sure that you review this information carefully to verify its accuracy.
These notices are typically computer-generated and may be erroneous. For example, one client received a CP2000 notice because her 1099-INT didn't match up with information reported on her tax return. The 1099-INT used the bank's full name. The tax return used an abbreviated variation of the bank's name. The IRS computer didn't know the banks were one in the same.
If you end up owing additional federal taxes after receiving a CP2000, consider the possibility that you may also owe additional state and local taxes.
Handling Your Notice
The IRS recently issued tips on how to handle notices. Here are some important points to bear in mind:
Follow directions. Each notice relates to a specific issue and instructs you about what to do. If the notice requires a response, only address the specific questions the letter asks. If you have other tax issues you'd like to discuss with the IRS, send a separate letter.
If you agree with the notice, you usually don't need to reply unless it gives you other instructions or you need to make a payment. Pay close attention to the proper mailing address for your response and deadlines. Always keep copies of any correspondence with the IRS. You may need to refer to it later.
Ignoring an IRS response will not make it go away. Generally, if you receive a notice that you owe additional taxes, the IRS perceives failure to respond as admission of underpayment, starting the collections process.
Stand your ground. You may receive a notice stating that the IRS has made a change or correction to your tax return. Review the information and compare it with your original return. If you don't agree with the notice, you still need to respond typically within 30 days (or 60 days if you live outside the United States). Don't sign the notice and never pay money that you don't think you owe just to get the IRS off your back.
You have the right to dispute the notice. Contact your tax adviser about composing a letter to explain why you disagree, including any information or documents you want the IRS to consider. Mail your reply with the bottom tear-off portion of the notice. Send it to the address shown in the upper left-hand corner of the notice. Expect to wait at least 30 days -- often 60 days or longer -- for a response from the IRS.
Pay promptly to minimize interest charges and penalties. You will be sent a bill from the IRS, if you owe additional taxes. Pay balances due to the IRS promptly, because interest and penalties quickly add up. Interest will be charged on any unpaid tax from the due date of the return until the date of payment. The interest rate is determined quarterly and equals the federal short-term rate plus 3 percent. Interest compounds daily.
If you file a return but don't pay all amounts shown as due on time, you will generally have to pay a late payment penalty of 0.5 percent for each month (or part of a month) up to a maximum of 25 percent, on the amount of tax that remains unpaid from the due date of the return until the tax is paid in full. The 0.5 percent rate increases to 1 percent if the tax remains unpaid 10 days after the IRS issues a notice of intent to levy. For individuals who file by the return due date, the 0.5 percent rate decreases to 0.25 percent for any month in which an installment agreement is in effect.
If you owe tax and don't file on time, the total failure to file penalty is usually 5 percent of the tax owed for each month (or part of a month) that your return is late, up to five months. If your return is more than 60 days late, the minimum penalty for late filing is the lesser of $135 or 100 percent of the tax owed.
The penalties for filing and paying late may be abated if you have reasonable cause and the failure was not due to willful neglect. In addition, making a late payment as soon as you are able may help to establish that your initial failure to pay was due to reasonable cause and not willful neglect. Generally, interest charges are not abated; they continue to accrue until all assessed tax, penalties, and interest are paid in full.
Consult with your tax professional. Taxpayers may be able to rectify minor IRS issues, such as an inaccurate address, account number or Social Security number. But other notices are better left to a tax professional. Response forms typically allow you to authorize someone other than yourself to contact the IRS concerning notices. Never hesitate to contact your tax adviser if you're uncertain about how to handle a letter from the IRS.
Common IRS Notices
IRS notices cover specific issues about an account or tax return. Here is a list of some common IRS notices (there are more than 100) and the reasons they are issued.