What is IRS Notice of Deficiency

IRS Notice of Deficiency: What It Means and How to Challenge It

Receiving a letter from the Internal Revenue Service (IRS) after the completion of an IRS Tax Audit comes in the form of a Notice of Deficiency, also known as a 90-day letter or CP3219A. This formal document signals that the IRS believes a taxpayer owes additional taxes, penalties, or interest based on discrepancies in their tax return usually after a tax audit. For taxpayers, understanding the notice and knowing how to respond is critical to protecting their financial interests.

What Is an IRS Notice of Deficiency?

A Notice of Deficiency is a legal document issued by the IRS under Internal Revenue Code (IRC) Section 6212. It informs a taxpayer that the IRS has reviewed their tax return and determined that they owe additional taxes, often due to underreported income, disallowed deductions, or miscalculated credits. The notice outlines the proposed adjustments, including the amount of additional tax, penalties, and interest, and provides a deadline—typically 90 days from the date of the notice—for the taxpayer to respond.

The Notice of Deficiency is a critical step in the IRS’s tax assessment process because it is the final notice before the IRS can formally assess the additional tax liability. If the taxpayer does not respond within the specified timeframe, the IRS can proceed with collection actions, such as levies or liens.

Key Components of a Notice of Deficiency

A typical Notice of Deficiency includes the following elements:

• Tax Year and Amount Owed: Specifies the tax year in question and the proposed additional tax, penalties, and interest.
• Explanation of Adjustments: Details why the IRS believes the taxpayer owes more, such as unreported income or disallowed deductions.
• Response Deadline: Provides a 90-day period (150 days if the taxpayer resides outside the U.S.) to file a petition with the U.S. Tax Court.
• Instructions for Response: Outlines the process for challenging the notice, typically by filing a petition with the Tax Court.

Below is a table summarizing the key components of a Notice of Deficiency:

Why Does the IRS Issue a Notice of Deficiency?

The IRS issues a Notice of Deficiency after auditing a taxpayer’s return or identifying issues through automated systems, such as the Automated Underreporter Program (AUR). Common reasons for receiving a notice include:

• Underreported Income: The IRS receives third-party information (e.g., W-2s, 1099s) that does not match the income reported on the tax return.
• Disallowed Deductions or Credits: The IRS determines that certain deductions or credits, such as business expenses or Earned Income Tax Credits, are invalid or unsupported.
• Mathematical Errors: Errors in calculations on the tax return.
• Unfiled Returns: In some cases, the IRS may issue a notice based on a Substitute for Return (SFR) if the taxpayer failed to file.
• After IRS conducts an examination of taxpayer’s individual or business tax returns.

The issuance of a Notice of Deficiency is a prerequisite for the IRS to assess additional tax liabilities, as required by law. It also provides taxpayers with an opportunity to challenge the IRS’s findings before the assessment becomes final.

Implications of Receiving a Notice of Deficiency

Receiving a Notice of Deficiency has serious implications:

1. Legal Deadline: The 90-day period (or 150 days for non-residents) is non-negotiable. Missing this deadline means the taxpayer forfeits their right to challenge the IRS’s determination in Tax Court, and the proposed assessment becomes final.
2. Potential Financial Impact: The additional taxes, penalties, and interest can be substantial, potentially leading to financial strain.
3. Collection Actions: If the taxpayer does not respond or pay the amount owed, the IRS may initiate collection actions, such as wage garnishment, bank levies, or property liens.
4. Credit Impact: Unresolved tax debts can negatively affect the taxpayer’s credit score and financial standing.

The following chart illustrates the potential financial impact of a Notice of Deficiency based on a hypothetical case where the IRS proposes $10,000 in additional taxes, with varying penalty and interest rates over time:

Chart: Growth of Tax Liability Over Time

Note: Interest is compounded daily; this chart uses a simplified annual rate for illustration.

This chart demonstrates how quickly tax liabilities can grow if not addressed promptly, underscoring the importance of responding to a Notice of Deficiency.

Steps to Challenge an IRS Notice of Deficiency

If a taxpayer disagrees with the IRS’s proposed adjustments, they have the right to challenge the Notice of Deficiency. Below are the steps to take:

1. IRS Notice of Deficiency Detailed Review

• Understand the Adjustments: Examine the IRS’s explanation of changes to determine whether they are accurate. Common issues include mismatched income reports or disallowed deductions.
• Gather Documentation: Collect all relevant records, such as receipts, bank statements, W-2s, 1099s, or other evidence to support your position.
• Check the Deadline: Note the exact date by which you must file a petition with the U.S. Tax Court (typically 90 days from the notice date).

2. Consult a Tax Attorney

• Engaging a tax attorney with experience in IRS disputes is highly recommended. A professional can:
  • Assess the validity of the IRS’s claims.
  • Help gather evidence to support your case.
  • Navigate the complex procedures of the U.S. Tax Court.
• A tax lawyer can also determine if alternative resolution options, such as an Offer in Compromise or installment agreement, are viable.

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

• Deadline: File a petition with the U.S. Tax Court within 90 days (or 150 days if outside the U.S.). The deadline is strict, and late filings are generally not accepted.
• How to File:
  • Obtain a petition form from the U.S. Tax Court website (www.ustaxcourt.gov) (www.ustaxcourt.gov).
  • Complete the form, specifying which parts of the IRS’s determination you dispute and why.
  • Submit the petition by mail or electronically, along with the filing fee ($60 as of 2025)
  • Include a copy of the Notice of Deficiency with your petition.
• Small Tax Case Option: If the amount in dispute is $50,000 or less per tax year, you can request a “small tax case” for simplified procedures.

4. Consider Alternative Resolution Options

• IRS Appeals Office: Before filing a Tax Court petition, you may request a conference with the IRS Office of Appeals, an independent branch of the IRS that can resolve disputes without litigation. However, this must be done before the 90-day deadline expires.
• Mediation: In some cases, the IRS offers mediation to resolve disputes informally.
• Payment or Agreement: If you agree with the IRS’s adjustments or cannot dispute them, you can pay the amount owed or request a payment plan.

5. Prepare for Tax Court

• If you file a petition, the Tax Court will schedule a hearing. You may represent yourself or have a tax attorney represent you.
• Gather evidence and prepare arguments to demonstrate that the IRS’s adjustments are incorrect.
• Be prepared for a trial, though many cases settle before reaching this stage.

6. Avoid Common Mistakes

• Missing the Deadline: Failing to file a petition within 90 days forfeits your right to challenge the assessment in Tax Court.
• Ignoring the Notice: Ignoring the notice does not make the problem go away; it leads to automatic assessment and collection actions.
• Incomplete Documentation: Failing to provide sufficient evidence weakens your case.

What Happens If You Don’t Respond?

If you do not respond to the Notice of Deficiency within the 90-day period, the IRS will:

1. Assess the Tax: The proposed tax, penalties, and interest become final and legally owed.
2. Initiate Collection Actions: The IRS may garnish wages, levy bank accounts, or place liens on property.
3. Limit Your Options: You lose the ability to challenge the assessment in Tax Court, though you may still pursue other remedies, such as paying the tax and filing a refund claim, which can be more complex.

Contact Us

An IRS Notice of Deficiency is a serious matter because a late or non-response could result in tax charges against you which subsequently leads to IRS tax levy and tax liens.

If you have further question about IRS Notice of Deficiency or other tax issues, contact us.

Disclaimer: Please check the latest tax laws and rules on Notice of Deficiency as IRS may have changed.