You know you are an adult when you go from being excited when you get the mail, to the feeling of ‘what now’ when you get something in the mail. The worst feeling in the world is getting mail and seeing that it is from IRS. That sinking feeling sits in, and you think about what it could be, or what happened, or is my phone bugged, and it is scary - - you just got a tax notice.
My first piece of advice when it comes to tax notices is: 1) take a breath, 2) calm down. It's usually something very simple, they’re wrong, or they’re right and it’s something that can be dealt with. In all cases, it should be handled and not ignored.
REASONS FOR IRS NOTICES
First of all, the IRS only sends letters/notices in the mail. Any other form (i.e.: A scary phone call) is NOT valid.
According to the IRS, the IRS sends notices and letters for the following reasons:
You have a balance due.
You are due a larger or smaller refund.
They have a question about your tax return.
They need to verify your identity.
They need additional information.
They changed your return.
They need to notify you of delays in processing your return.
And their advice is:
Read the notice
Respond by the date requested (to minimize interest and penalty and to preserve your appeal rights)
Pay as much as you can, even if not all requested
Keep a copy
Contact them with questions
Verify if it looks suspicious (IRS.Gov has a phishing page to do this – or call them)
WHAT TO DO
I would say, given what the notice says, call your tax preparer, Enrolled Agent, CPA, or Attorney first, as in the remainder of the article, you may have other options beyond what they initially ask you to do.
CP2000 – Notice of Proposed Adjustment (More depth on this later)
CP12 – Notifying you of corrections made by IRS of one or more mistakes on tax return.
CP2501 – Tax Return Discrepancy – requesting clarification on a discrepancy regarding information on tax return that does not match IRS records.
Letter 2205 – Return Selected for Examination - THE SCARY ONE, you are getting audited.
Letter 525 - Examination Report – Results of the Audit.
Letter 3219 – Notice of Deficiency – You have not paid all your taxes due, and they send this as a follow up ‘Bill’, unless you request to go to Tax Court.
Letter 12C – Information Request – IRS just needs more information, and they outline what they need in this letter.
CP 90 – Final Notice of Intent to Levy – You still owe money, and have not paid, so they are letting you know they intend to Levy.
CP01 – Identity Theft – This is informational notice that the IRS is monitoring your account to prevent future fraud.
Letter 3391 – 30-day Non-filer Letter – Stating they don’t have a tax return, they are ‘filing’ one for you, with a proposed amount, and you have 30 days to appeal.
Letter 6002 – Health Care Coverage – You did not indicate you had Health Care, or not, and may need to amend accordingly.
Most of these are self-explanatory, but I am going to spend some time on the ‘CP’ notices below. (CP stands for “Computer Paragraph”):
CP Notices, and notably the CP2000 Notice of Proposed Adjustment is one of the most common notices I see. The IRS depends heavily on what I refer to as the ‘Computer Matching System.’ (Anything with ‘CP’ is referring to this) With the CP2000 certain tax documents the IRS will get a copy of. Notable examples are: W2, 1099 (all types), K-1’s, etc. IF you do your tax return where you got a 1099 and did not put that 1099 on the tax return, then the ‘Matching’ system will spit out a notice. Generally, and commonly, it’s something that may have been properly recorded on your tax return, but it just did not get matched.
Sally Taxpayer is self employed and get’s 1099’s for her services. She got a total of three 1099’s, for $15,000 total income. She put $15,000 on her tax return but did not put the 1099’s on (or attach them – if E-filed you have to input the information specifically for this ‘CP’ system). The IRS does not intuitively match the 1099 to the income, rather it looks for the 1099 input on the return, if it does not see it, a CP-2000 will be spit out. The notice will say something like: According to our records Sally Taxpayer had $15,000 of income and it is not on Sally’s return, you owe us $2,250 in tax plus interest in Penalties (exact tax in not calculated but made up for illustrative purposes). Sally has this scary tax due to the IRS. In reality Sally owes them $-0- because Sally Taxpayer already reported and paid this tax on her timely filed tax return (without the 1099’s ‘attached’). tthis example highlights that the CP2000 does not consider income that was properly on the return as filed, just improperly inputted.
Response: In a paraphrase – you, or your tax preparer, has to respond to this notice saying : “ Thank you for bringing this matter to our attention, this income was properly reported on the Schedule C – see attached for your reference” and attach a copy of the return.
NOTE: The ‘Computer Matching System’ is a computer, it is not a human, and though it may be common sense to us, it is not to a computer looking for a match. When you respond with a letter, explanation, and proof (Tax return) – it causes it to be ‘put on an actual person’s desk’ and this human being can look at it, apply logic, and disregard the notice.
Another common CP-2000 may be a situation where there is someone that sold stock. Say Tommy Taxpayer has $1,000, and for fun Tommy decides to play around and ‘day trade.’ He buys stock for a $1,000, sales it for $1,000, buys another stock for $1,000, sales it again, and so on. Say Tommy isn’t too good at this, and after three months of ‘playing’ with this money he only has $500 stock in his portfolio. This is the scary part. All those trades (and let’s say he bought/sold 15 times during this period) get reported on a 1099-B. Tommy doesn’t think about this at tax time because he only has $500, and he didn’t make money, so he does not think to look for this 1099-B from his trade software. BUT, the IRS get’s a copy of it. And the only information they get a copy of is the sales price. Tommy will get a CP-2000 which will say, according to our records you sold $15,000 in stock and you owe us $2,250 in tax plus interest in penalties. (exact tax in not calculated but made up for illustrative purposes). The IRS sees all those times he sold it (15 times, at about $1,000 each) but does not see his ‘cost basis’, which in this scenario was a cumulative $15,500. Had Tommy put this on his tax return, he would have recorded $15,000 in sales, $15,500 in cost, with a $500 Loss. But nope, he didn’t, and now he has this big bill. This example highlights that the CP2000 does not consider the cost basis of stock sold.
Response: Probably will have to amend the return to get the proper cost basis on there, and he may even get a refund due to the loss that was not originally on there. You have to write a letter (paraphrased) stating something like: Thank you for bringing this matter to our attention, this notice fails to consider the cost basis of the stock, and an amended return has been filed to properly record this transaction.
Another common CP-2000 states you missed a 1099, that you either forgot, or did not know you were going to get, and you just did not put it on your tax return. Sometimes it is valid, and the best advice would be to respond to the notice with full payment.
All states ‘Piggyback’ the IRS. If you got an issue with the IRS, the state will find out about it, and vice/versa, so always keep the state in mind if a change is made from the IRS (or keep the IRS in mind if a state makes a change). States are similar to the IRS but they are all different in how they specifically handle issues. Some states are more aggressive than others, and some it just depends on the issue, or even the individual agent. And keep in mind, states regulate taxes that the IRS does not, like sales taxes, for example.
If at the end of the day you owe the IRS money, the IRS (and states) are not forgiven on the tax owed or interest - sometimes you may qualify to ‘get out’ of penalties for cause. In other words, tax and interest is not negotiable, penalties may be. It should also be noted that payment plans are an option (where with the IRS, in most situations, if the balance is paid off within 72 months they will accept a payment plan) , as well, if qualified, an offer in compromise (where you make a counter offer to your taxes owed, though this is a long process that almost requires professional help).
We hope you found this information helpful. At the end of the day, don't avoid the notice by doing nothing. As we stated earlier, depending on the notice, call your tax preparer, Enrolled Agent, CPA, or Attorney first. Avoiding notices can create additional problems.
-John Michael Kledis EA, CFE, CVA is Principal and founder of Peridot Consulting, Inc.
Disclaimer: This is a brief synopsis and individual situations may vary. The above has left out many details for summation purposes. Do not take any advice from this column and please consult with relevant parties before making any decisions regarding the subject matter within. Any U.S. federal tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this blog. This blog has conveniently left off fun things to do while at the beach, or on vacation. It was not intended for the blog to cover such matters, although, vacation is probably a more fun topic than tax notices.