Anxiety. Dread. Annoyance. Irritation. Chances are that if you have ever received a notice from the IRS, your immediate reaction was one of these emotions—followed closely by questions like:
Why me? If the IRS only audits a small percentage of returns, why am I receiving a letter? Is focusing on my return really the best use of the IRS’s time? What happened? Is this right? Do I really owe more money? How do I fight this? How much is it going to cost me to resolve this?
IRS notices are common these days. What most people do not realize, however, is that an IRS notice is not the same as an IRS audit, and the intensity of the emotional reactions they elicit is usually far out of proportion with the severity of the issue.
So you may wonder how you can tell the difference between the two and what it would mean for you, if you were to receive an IRS notice in the future. Below are some of the more common questions our office receives, along with explanations, which we hope will shed some light on the issue.
Although they are inquiries, notices often take the form of an assessment—correcting your return according to the information the IRS has on file and levying additional tax, interest, and/or penalties (or in some cases, increasing your refund). Consequently, they appear to be definitive. This is not the case. The IRS merely wants you to resolve the discrepancy and has provided a format that (1) encourages you to respond, where the IRS information is incorrect, and (2) offers you a simple solution, where the IRS’s information is correct.
Tax notices are very common and are issued automatically—without human intervention. A notice may be resolved either (1) by providing evidence that the discrepancy is due to incomplete or incorrect information in the IRS’s records, or (2) by acknowledging that the IRS’s records are correct and accepting the IRS’s revised calculation of your tax, interest, and/or penalties.
Tax audits, however, are less common, and the IRS uses a mix of computer selection and human review to identify a taxpayer for audit. An audit notice outlines the specific documentation needed to justify amounts reported on your tax return, and it can only be resolved by providing official documentation to substantiate those amounts.
An audit also has several distinguishing features. First, it will specifically include the term “exam” or “examination” in the upper left corner of the first page. Second, it will provide the name and specific contact number for the IRS examiner assigned to your case. Third, it will begin with a note informing you that the IRS is examining your return and will identify the items under scrutiny. (It may or may not indicate the IRS’s proposed corrections.) Fourth, it will provide instructions for how to respond to the exam. And finally, it will provide you with forms or a list of documentation that you must complete or provide in order to fully respond to the exam.
- Payment discrepancies—If you make quarterly estimated tax payments, extension payments, or payments of balances due, the IRS records those payments in your account. However, we commonly see cases in which the IRS has cashed a check but has not credited the payment to an account. We also commonly see cases where individuals have reported a different amount of payments on their return from what was actually paid.
- Assessment of interest and penalties—The IRS charges interest (and penalties, in certain cases) on any balances due that are paid after the April 15 filing deadline. Unfortunately, if you file an extension, this only extends the due date for your tax return, not the due date for paying any tax you might owe. Thus, if you file a return after April 15 and that return shows a balance due, you will owe interest on that balance.
Since the IRS assesses daily interest charges, the exact interest charge is not fixed until the IRS processes your return and credits your payment. Therefore, you may receive a notice from the IRS with the exact calculation of interest and penalties. The notice will reconcile the final amount of tax, interest, and penalties with the amounts that you have paid and then will request or refund the difference.
- Adjustments from prior years—If there were changes to one of your prior-year returns (either from an earlier tax notice or from an amendment), those changes could have a domino effect and affect the carryovers or calculations on your current-year return. We frequently see cases where the IRS levied interest or penalties on a prior-year return and since it did not receive payment of the interest and penalties, it took them out of an estimated payment amount intended for the current year.
- Income discrepancies—When you earn wages, interest, dividends, or other income, the payer of that income will generally send both you and the IRS a copy of your W-2, Form 1099, or other tax statement to report payment of the income. When the IRS receives your tax return, it will then attempt to confirm that you have reported those income amounts on your return. If the IRS is unable to clearly identify an income item on your return, it will issue a notice to resolve the discrepancy.
The notice will provide instructions at the end. If you agree with the changes, you should follow the instructions and pay any additional amounts due. If you disagree with the changes, you can either call the IRS or send the IRS a letter (preferred) to explain and substantiate your position.
If you are not sure how to proceed, we recommend that you contact your tax practitioner. Most practitioners will assist you in addressing the notices (generally at hourly rates).
The Wolf Group offers our clients audit insurance. If you have purchased audit insurance, we ask that you send us a copy of the notice, and we will assist you in resolving the matter free of charge (up to a certain number of staff hours).
It is also important to keep in mind that before the IRS (or state tax authorities) will discuss your notice with a tax practitioner, the IRS must have a signed Power of Attorney on file allowing the practitioner to represent you. Thus, if you would like your practitioner to request an extension for you, you should plan at least several days in advance, to allow enough time for your practitioner to prepare the Power of Attorney and obtain the requisite signatures.
If, however, you disagree with the proposed changes, the process takes longer. From the time you respond to the notice, you can expect a turnaround time of approximately 8 to 12 weeks, per the IRS. If the IRS has a backlog, it will send you a letter indicating the additional time that it will take to respond (typically an additional 30 to 60 days).
Although the IRS’s systems are improving, there is still a lag between the time you send your response and the time the IRS updates its records. During this time, the IRS computer systems continue to issue automated notices.
While you may be able to disregard the additional notices, we recommend that you contact the IRS just to be safe, to request that it put a hold on your account until your original response can be processed. Please be aware that the IRS agent may inform you that the hold may or may not stop you from receiving additional notices.
The most common reasons that states issue notices include the following:
- No return received—If you used an in-state mailing address on your federal tax return but did not file a state tax return for that state, the state may request a copy of your return or an explanation for why you do not need to file a return in that state.
- Confirmation of change in residency—The state is requesting proof that you are no longer a state resident or domiciliary.
- Payment discrepancies—The state’s records of your estimated payments, extension payment, balance due payments, or withholding do not match the amounts reported on your return.
- Amounts attributable to other states—If you have income from and pay taxes to more than one state, then states may request substantiation of taxes paid or income attributable to other states.
The process for resolving a state notice is similar to that for resolving federal notices. It is usually faster, however, to call the state directly. Representatives tend to be easier to reach than IRS agents.
The articles in this newsletter is not intended as legal or tax advice, and cannot be relied upon for any purpose without the services of a qualified tax professional.