In a world of electronic communication, who doesn’t love getting a letter? As long as it’s from a friendly face and not signed, “your friend, the Internal Revenue Service.” But if you’re one of the lucky millions who receive a letter from the IRS each year, what should you do?
Job one: OPEN THE LETTER. Anything from the IRS is nerve wracking, I know. I see them all the time and they still make me jump a little. But ignoring it won’t make it go away, and if you do owe them money there’s already a penalty and interest clock ticking so the sooner you address it the better for you financially.
Most of the time the notice is of the CP-2000 variety and generated by the AUR (automated underreporter) function. That is when the IRS computers match up the taxes you filed with the income documents submitted under your social security number. When there is a discrepancy, like the IRS has a 1099-R showing a retirement account distribution but you don’t show it on your tax return, the tax due on the underreported income is calculated and a notice is generated telling you what income was not reported, how it changed your return, and how much additional tax, penalty, and interest you now owe according to their calculations. Or it could be a notice for omitting 1099 income from a side job you forgot about or missing bank interest. Other types of notices may request proof for deductions or credits taken on the return, especially if it’s a hot topic with the IRS like the American Opportunity Tax Credit for college tuition.
Job two: DON’T PAY THE BILL until you’ve either looked it over very carefully yourself and are sure you really do owe
the tax, or GET HELP and have a professional (Enrolled Agent, CPA, or tax attorney) examine it for you. Even though with the IRS you seem to be presumed guilty until you prove your innocence, there are many instances where their notices are flat out wrong or the tax bill is not as high as they calculate because they don’t reduce your non-reported income by any deductions to which you would be entitled.
That 1099 from the side job? By the time you subtract the expenses incurred in earning the money, the actual tax due may be substantially less than the IRS is billing you for. And if you get a notice about a stock sale, you can be sure they’re going to tax the whole thing as profit when in reality you might have even had a loss- meaning they owe YOU money instead.
The most bizarre notice I’ve ever seen claimed the taxpayer received over $100,000 in income from odd sources such as fishing income and medical receipts. We were stumped as to how they came up with those numbers until she solved the puzzle by noticing the numbers corresponded to dates, addresses, and other random fields on a 1099 she received. My theory is when it was entered into the IRS system it translated to a different type of 1099 form and generated the completely misidentified income. The IRS cleared her account but left out the apology.
Job three: RESPOND QUICKLY- if you do owe additional tax the sooner you pay the cheaper it will be. Your first notice will give you the option to accept the changes as proposed or to disagree with some or all of the changes. If you agree and the amount due is provided (some notices indicate they will bill you later), pay it right away if you can, or agree and apply for an installment agreement. But it’s almost always cheaper to borrow the money elsewhere than from the IRS.
If you don’t agree, you or your representative can fax or mail a letter outlining the reasons and including proof, requesting a review of your case. In your response you can also authorize your representative to address the matter on your behalf and receive notices.
Don’t expect a reply from the IRS for several weeks, and in fact the first correspondence you receive from them may simply be to tell you they need more time. When they owe you money that’s not so bad because the interest they’ll pay you is accruing while they work on it.
Most times the first letter to them is enough to adjust the account as requested, but the IRS may come back and ask for additional substantiation before they’ll accept your argument. Don’t ignore that one either, because if these notices are ignored long enough they can end up with you in tax court. Don’t be that guy.
One of the ugliest notices to get from the IRS is the one that lets you know they noticed you haven’t filed your taxes for a while so they very kindly did it for you by creating a substitute return. Don’t be that guy either. But if you are you better read the next post.