Accounting news has been reporting an increase in audits of high income taxpayers. In fact, I have personally seen an increase in the number of IRS notices that my clients have been receiving. If you receive an IRS Notice the most important thing to remember is DO NOT PANIC.
As was illustrated in last weeks’ blog, there are many reasons why you could be receiving a notice that do not include an actual deficiency. As the IRS becomes increasingly automated, the number of erroneous notices also increase. For example, last week a client received a notice claiming that retirement income of $3,349 was not included on their return. In fact, the $3,349 was a direct rollover that WAS reported on the return in a “rounded” amount of $3,350. Although a human being looking at the return would have matched the income up properly, the automated systems did not.
After you’ve slowed your heart rate and avoided the initial shock of receiving a notice, read the entire notice with particular attention to the stated deficiency and the due date of your response. Occasionally a taxpayer misplaces a tax form or receives it after their return is prepared and therefore there is indeed income missing from their tax return. Again, do not panic. In this case, you may owe additional taxes, but an honest mistake will not get you thrown into tax court or jail!
Also note that the IRS does not correspond via e-mail. Identity thefts frequently attempt to obtain personal information by posing as the IRS. Do not respond to e-mail that appear to be from the IRS.
Contact your tax advisor. I have a client that for years, upon receiving a notice would simply pay the amount shown; until the day he received a notice that claimed a $10,000 amount due. That day he came directly to my office, and in fact the notice was erroneous and there was no amount due. He was very glad he came to us. For years his feeling was that he didn’t want to “mess with the IRS.” However, you should not simply pay without understanding the notice. Therefore, contact your advisor so that they can review your return and properly advise you.
React promptly. As humans when we are intimidated by a situation or overwhelmed by it; we tend to put off action. Instead, take notice of the date your response is due and promptly contact an advisor.
Draft a letter of Response. Whether your tax position or the IRS position is correct; a letter of response should be drafted. Your advisor will typically draft the letter for you, but you will need to review and sign the letter. The letter should include a reference to the Notice number, an explanation of why you agree or disagree with the IRS findings, your conclusion, and a list of enclosed documents.
Be crystal clear. Include all documents that support your position even if the IRS should already have copies of the information. Using the example of the IRS asserting that retirement income was not reported: I would include a copy of the Form 1099R and a copy of Page 1 of the Form 1040. In the letter I would reference the specific line item on page 1 that the income is reported on. A sample letter is included at the end of this blog.
Consider requesting an abatement of penalties. If you find that the IRS position is correct, you will be required to pay the deficiency and interest due. However, if the deficiency is due to an honest error, you may explain the error and request abatement of the penalties. My experience has shown the IRS to be responsive to such requests. A sample request is included at the end of this blog.
Fill out the response form. The IRS provides a response form to fill out. If you have questions, your advisor can assist you. The form must be completed in full and signed by you.
Assemble your package. Before the due date of your response, gather (1) Your response letter (2) the IRS response form (3) the source documents that support your position. If you have determined that you owe a payment, the payment should also be included. The IRS provides addressed envelopes for your response. Mail the package certified mail, return receipt requested.
Unfortunately, IRS notices are becoming increasingly common. Therefore, take a deep breath and follow these above steps should it become necessary.
SAMPLE RESPONSE LETTER:
John Smith
Taxpayer Way
Boston, MA 00000
January 19, 2012
Department of Treasury
Internal Revenue Service
Ref. Notice # XX0000 dated January 3, 2012
Form 1040 Tax Year 2010
To whom it may concern:
Notice XX0000 dated January 3, 2012 identified $3,349 of retirement income from Local Bank Co. as not being included on the 2010 Form 1040. As shown in the copy of Page One of 2010 Form 1040 enclosed, Line 15a reflects a $3,350 IRA distribution which represents the Local Bank Co. income as appropriate. The IRA distribution was a direct rollover as reflected on the Form 1099-R as a Box 7 Code G “direct rollover,” (1099-R also enclosed). Therefore, there should be no adjustment to the 2010 tax return.
Also enclosed for your reference is the signed Response Form.
Thank you,
John Smith
SAMPLE WITH REQUEST TO ABATE PENALTIES:
John Smith
Taxpayer Way
Boston, MA 00000
January 19, 2012
Department of Treasury
Internal Revenue Service
Ref. Notice # XX0000 dated January 3, 2012
Form 1040 Tax Year 2010
To whom it may concern:
We agree with the changes made in Notice XXX0000 dated January 3, 2012. Although we are not in possession of the 1099 in question we did receive interest income from Local Bank Co. during the tax year. Therefore we concede that the additional tax is properly due. We feel that it is likely a result of the relocation of our primary residence during the 2010 tax year that the 1099 was misplaced or never received and therefore not provided to our tax preparer. As such, we respectfully request that the penalty of $100 be abated.
Enclosed is payment of $1000 which represents payment in full of the additional tax levied and the associated interest. We have also enclosed the signed Response Form.
Thank you.
John Smith
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