IRS Notice of Deficiency

Understanding and Responding to an IRS Notice of Deficiency

Receiving a Notice of Deficiency from the Internal Revenue Service (IRS) indicates a potential tax liability usually stemming from an IRS tax audit. This formal document, also known as a “90-day letter,” signals that the IRS has determined a discrepancy in your tax return, resulting in a proposed increase in your tax liability. Understanding what a n IRS Notice of Deficiency is, its implications, and how to respond effectively is critical to protecting your financial interests.

What is an IRS Notice of Deficiency?

An IRS Notice of Deficiency is a legal document issued by the IRS under Internal Revenue Code Section 6212. It informs a taxpayer that, after reviewing their tax return, the IRS has identified a deficiency—meaning the amount of tax reported is less than what the IRS believes is owed. This notice of deficiency typically arises after an IRS tax audit or examination of a tax return, though it can also stem from automated processes, such as discrepancies between reported income and third-party documents like W-2s or 1099s.

The notice details the proposed changes to your tax liability, including additional taxes, penalties, and interest. It also specifies the deadline—usually 90 days from the date of the notice—for taking action to dispute the IRS’s findings. Failure to respond within this timeframe can result in the IRS assessing the proposed tax deficiency, leading to enforced collection actions, such as wage garnishment or bank levies.

What Does an IRS Notice of Deficiency Do?

The Notice of Deficiency serves several critical functions:

1. Formal Notification: It formally notifies you of the IRS’s proposed adjustments to your tax return, ensuring transparency in the process.
2. Legal Prerequisite: The IRS is required to issue a Notice of Deficiency before assessing additional taxes or penalties, except in certain limited circumstances. This protects your right to challenge the IRS’s findings.
3. Opportunity to Dispute: The notice triggers your right to contest the proposed deficiency in the U.S. Tax Court without first paying the disputed amount, a unique feature of tax disputes.
4. Time-Sensitive Deadline: It establishes a strict 90-day period (or 150 days if you reside outside the U.S.) to file a petition with the Tax Court. If you miss this deadline, you lose the ability to challenge the deficiency in Tax Court before paying the assessed amount.

How to Respond to an IRS Notice of Deficiency

Receiving an IRS Notice of Deficiency requires prompt and strategic action. Below are the steps to take, along with considerations to ensure the best possible outcome:

1. Notice of Deficiency Has Strict Timelines

• Understand the Details: Examine the notice to identify the tax year in question, the proposed adjustments, and the IRS’s reasoning. Compare the notice with your tax return and supporting documents to pinpoint discrepancies.
• Check the Deadline: Note the 90-day deadline for filing a petition with the Tax Court. This date is non-negotiable, so mark it on your calendar and act well in advance.

2. Assess Your Options

You generally have two primary options when responding to a Notice of Deficiency:

• Agree with the IRS: If you believe the IRS’s adjustments are correct, you can sign and return the enclosed Form 5564 (Notice of Deficiency – Waiver) to accept the proposed changes. This allows the IRS to assess the deficiency, and you can arrange to pay the amount owed, potentially through a payment plan.
• Dispute the Notice of Deficiency: If you disagree with the IRS’s findings, you can challenge the deficiency by filing a petition with the U.S. Tax Court before the 90-day deadline. This option allows you to contest the IRS’s determination without paying the disputed amount upfront.

3. Gather Supporting Documentation

If you plan to dispute the notice of deficiency, collect all relevant records, such as receipts, bank statements, canceled checks, or other evidence supporting your tax return. These documents are crucial for substantiating your position, whether in negotiations with the IRS or in Tax Court.

4. File a Petition with the U.S. Tax Court

If you choose to challenge the deficiency, you must file a petition with the U.S. Tax Court by the 90-day deadline. The petition is a formal document that outlines your disagreement with the IRS’s proposed adjustments. Key considerations include:

• Small Tax Case Option: If the disputed amount is $50,000 or less per tax year, you may qualify for a simplified “small tax case” procedure, which is less formal and typically faster.
• Legal Representation: While you can represent yourself in Tax Court, having an attorney can significantly improve your chances of success, particularly in complex cases.
• Filing Logistics: Ensure the petition is filed correctly and on time, either electronically or by mail, to the U.S. Tax Court in Washington, D.C.

5. Explore IRS Settlement Options

Even after filing a petition, you may have opportunities to settle with the IRS through the Office of Appeals or during Tax Court proceedings. Settlements can reduce the disputed amount or establish a manageable payment plan, avoiding a full trial.

Contact Us.

Responding to an IRS Notice of Deficiency requires a clear understanding of tax law, IRS procedures, and Tax Court rules. Mistakes or missed deadlines can lead to significant financial consequences, including substantial tax assessments and penalties.

If you’ve received a Notice of Deficiency, contact us today for a consultation. Our experienced tax attorneys are here to provide the expertise and support you need to resolve your tax problems with IRS.