The IRS Notice of Deficiency is one of the most important letters it sends out. It’s so important because it gives you rights to dispute the amount of tax the IRS says you owe. If you don’t respond, you will likely be stuck with the tax due even if you don’t really owe that much. So, how do you avoid having this happen to you and how do you respond if you get this type of letter? Here is how to respond to an IRS Notice of Deficiency.
There are two ways the IRS issues a Notice of Deficiency:
1) Substitute Return
When you don’t file a tax return, the IRS is able to file a return for you, called a substitute return. It uses information that has been reported to it by anyone who files a 1099, W-2, or other document telling the IRS they have paid you money in that tax year. The IRS will calculate your tax liability and won’t use any deductions beyond what are standard and will not consider your particular circumstances such as the cost of your investment or otherwise deductible business deductions. This is highly likely to result in a tax bill that’s greatly overstated. For example: You sold stock for $20,000. You did not file your tax return for that year. The IRS will calculate the tax based on the sale price of the stock and will not consider that you actually bought the stock years ago for $25,000. In reality, you had a loss on the sale and wouldn’t otherwise pay any tax on that sale. The amount due from the substitute return will be reported and sent to you on a Notice of Deficiency.
2) Discrepancy from Audit Findings
If you are audited by the IRS, it may result in a balance due if the IRS believes you have underreported income or over-deducted expenses. An audit comes in two forms: 1) a desk audit, where they simply send you a notice that they found an error on your return; or 2) a field audit where the IRS comes to your home or business and does a thorough review of your financial records. Throughout the audit process you will be given an opportunity to dispute the opinions of the auditor. Sometimes the auditor will work with you to find a resolution before issuing his/her final audit findings. Other times, the auditor will take a hard line with his/her opinion and issue the audit findings right away. You then have the chance to appeal the decision. When you appeal you work with someone from the IRS Office of Appeals and get a fresh set of eyes on your case. But, in the event the appeals officer does not agree with you, it will issue a Notice of Deficiency to close its file. Click here for a few reasons you might want to consider working with a tax relief professional for this process.
Responding to a Notice of Deficiency
The Notice of Deficiency is also often referred to as a “90-day letter” and also a “statutory notice of deficiency.” These are all the same thing. You are given 90 days from the date on the letter to file a petition with the United States Tax Court to dispute the amount of tax on the IRS Notice. The 90 days is a strict deadline. Again, it’s not from the date you get your letter. It’s the date identified on the letter. The 90-day deadline will also be stated.
Filing a petition with the Tax Court is a lawsuit with the federal government. Instructions to do this are online here. Once you file the petition, your case will be routed to the IRS Office of Appeals to review your case prior to going directly to the IRS attorneys. This will give you another chance to explain why you shouldn’t owe the tax. This is especially important when you disagree with an auditor’s decision about how it treated something on your return during the audit.
If you have received a Notice of Deficiency because you didn’t file your tax return, you don’t have to go to Tax Court. You can prepare and file your tax return including the information that the IRS did not consider with its substitute return. You should contact the IRS at the phone number appearing on the Notice of Deficiency to be sure to get correct instructions on where to file your return. If you do this within three years following the original due date of the return, you will still be eligible to receive a refund if you’ve paid too much in for that tax year.
Remember: No tax is assessed against you until you receive a final determination from the IRS. The Notice of Deficiency is not a final determination. As long as the case is in the Tax Court system or otherwise being reviewed by the IRS, you don’t owe any tax and there will be no collection action taken against you. However, also know that the statute of limitations begins to run only after the tax is assessed.
In all cases, you take IRS notices very seriously. In this case, whether you’ve been audited or you haven’t filed returns, the Notice of Deficiency is especially important to pay attention to. Missing the 90-day deadline could make a big difference in the amount of tax you owe.