Every taxpayer at one time or another will get some type of correspondence from the IRS, but many are unaware of the proper steps to take in responding to it.
The first step, while seemingly obvious, can be the most difficult for some taxpayers - open the notice and read it carefully. What is the letter regarding? Often letters are not audit notices or requests for financial documentation. The IRS through its automated computer systems, generates a myriad of mailings, including copies of forms for paper filing and estimated tax vouchers. Therefore, before panic sets in, open the letter and determine why the IRS is trying to contact you.
After reading the notice, you will have an understanding of what, if any, information the IRS is seeking. Depending on the information requested, the IRS is generally either adjusting your filed tax return or auditing certain items on the return. If the notice regards the former, the Service’s computer system may have found a discrepancy between the tax documents submitted using your social security number and those amounts reported on your tax return.
For example, when making distributions from an IRA, the payer is required to issue a Form 1099-R showing the amount of taxable distributions. One copy of the Form 1099-R is sent to the IRS and another copy is sent to the taxpayer for use in preparing the income tax return. Upon the filing of the return, the IRS will match the 1099-R received with the amount recorded on the tax return. If there is a discrepancy between the two, the IRS will issue a “matching” notice along with a tax adjustment computation.
Generally, these types of notices are straightforward and easy to deal with. The response to the matching discrepancy is clear-cut – does the taxpayer have the documentation supporting the difference between the figures on the tax return and those which appear on the form submitted to the IRS? If yes, check the box that you disagree with the IRS’s proposed tax changes detailed on the notice and attach a short letter with the supporting documentation within the timeframe given. Remember to keep a copy of all correspondence mailed to the Service. The IRS generally responds within 60 days and will either agree or disagree with your assertion. If in agreement, the matter will be closed and no further action is necessary.
If the IRS disagrees, or if the original notice is an audit letter requesting the presentation of financial documentation either by mail or in person, then a more thorough response is necessary. Often the notice will include an information document request (“IDR”), listing numerous financial documents that must be submitted to the assigned audit agent. Sometimes this list will include documents that are not at all applicable to a taxpayer’s return. What is vital in this situation is for you to immediately place a phone call to the auditor. Timely, verbal communication with the auditor will demonstrate to the agent your sincere intentions of supplying the requested documents and will possibly allow you to determine what specific items on your tax return the auditor is scrutinizing. Many times auditors will tell you they are focusing their efforts on a certain schedule of your tax return. In that case, rather than submit the laundry list of documents per the IDR, you can simply provide the materials relating to the schedule under review.
After the initial conversation with the auditor, you should mail the auditor a letter confirming your conversation, including any agreements, such as for limiting the scope of requested documents or for extending the submission deadline or date set for an audit meeting. You will next need to either mail the requested documents or have the documents available for your meeting with the agent. In either case, the auditor will review the documents and give you an opportunity to answer any questions pertaining to the materials. Once all information has been exchanged and reviewed, the auditor will send you either a “no change” letter, if all the documentation checks out, or a proposed statement of changes, if additional tax liability is determined. At this juncture, you have the option to either acquiesce to the agent’s findings, or continue to defend your tax position. If you continue to protest the audit proposal, you will have a limited period of time to submit additional documentation. At the close of this period, if your position is not substantiated, the auditor’s findings will become final and an assessment for the tax liability, including interest and penalties, will be issued. If you are successful in supporting your tax position per your return, a “no change letter” will be provided to you.
Overall, when opening that dreaded IRS letter, you need to keep things in perspective. If the notice regards a small tax item, you may want to pay the tax assessment and move on rather than risk bigger issues by picking an unnecessary fight with the Service. Of course, determining what is a small issue versus a big issue on your tax return is relative. If you do seek to contest a notice and do not have the expertise, the best policy is to hire a tax professional or your tax return preparer, if you do not prepare it on your own, to review the notice and plan a coordinated response. Tax professionals who have the requisite expertise can often secure more favorable taxpayer results, even when supporting documentation is inadequate.
For more information on the impact of IRS notices on you and your business, contact Alan Goldenberg, Manager of Tax Controversy and State and Local Tax, at firstname.lastname@example.org or 212-897-6421, or contact your Friedman LLP tax professional.