What to Do If You Receive an IRS Notice

It's a moment many taxpayers dread. A letter arrives from the IRS and it's not a refund check. But don't panic; many of these letters can be dealt with simply and painlessly.

Each year, the IRS sends millions of letters and notices to taxpayers to request payment of taxes, notify them of a change to their account or request additional information. The notice you receive normally covers a very specific issue about your account or tax return. Each letter and notice offers specific instructions on what you are asked to do to satisfy the inquiry.

  • What you should do – Is immediately mail or Fax the correspondence to this office so it can be reviewed and timely responded to.
  • What you should not do – Is to set it aside until later. Notices that are not responded to cause additional notices to be issued and each additional notice brings with it additional complications and make it more difficult to resolve the problem.

Most notices are computer-generated after comparing the income items reported on your return with those reported by the payers. For example, your employer sends you a W-2 every year and also sends a copy to the government so that your wages are on the IRS computer. Your bank sends the 1099INT to the IRS showing how much interest you earned. Your brokerage firm reports your dividends and gross proceeds of sale from security transactions with 1099DIV and 1099B forms. If you are self-employed, those who pay you $600 or more during the year are required to send you a 1099-MISC. If you are retired and collecting a pension or drawing on your own IRA, a 1099R will be sent to you. Lenders report how much interest you paid on your home loan during the year. If you are lucky enough to hit it big in Vegas, you will receive a 1099G for your winnings. The list goes on and on, and if what you reported on your return doesn't match what is on the IRS computer, you will receive a computer generated notice.

One big problem that has developed over the years is the IRS willingness to allow payers to use substitute forms that are unrecognizable as income-reporting documents. Many of the brokerage firms are now providing their substitutes in letter size documents printed front and back on multiple sheets that almost takes a financial expert to understand. This results in frequent errors.

There are times when you may receive an income item and it appears to be taxable to the IRS when in fact it is not. Here are some frequently encountered situations:

  • Sold a security with no profit – Whenever you sell a security, the brokerage house will report the gross proceeds of sale to the IRS. In other words, the IRS has on their computer what you sold it for. They have no clue what you paid for it, which means you must report the sales on Schedule D on your tax return. If you fail to report it, the IRS treats the entire sales price as a profit. Let's say you sold 200 shares of stock which originally cost you $5,050 for $5,000. You actually have a loss of $50. Unless you report the transaction and show that you paid $5,050 for the shares, the IRS is going to assume you had a $5,000 profit. This frequently occurs when taxpayers overlook a transaction or simply omit it because there was no profit. If this is what caused the notice, you will need to respond to the IRS to explain the mistake and provide verification of the stocks' original cost.
  • Rollovers – Another frequent error is when you rollover an IRA, 401(k), etc. from one plan to another or one trustee to another. If you don't show on the tax return that the distribution was rolled over, the IRS assumes the entire amount to be taxable. If these funds are transferred between trustees, a 1009R is not supposed to be issued but sometimes they still are. It is better to make sure. On the other hand, if you take possession of the funds and then redeposit them into another IRA a 1099R will be issued and the rollover must be accounted for on the return. If this is what caused the notice, you will need to provide a verification of the rollover to the IRS with your response.
  • Shared accounts – Generally, banks and other financial institutions only have the capability of having one taxpayer ID on an account as the primary owner even though it may be a joint account with others. These financial institutions will issue the 1099 on other reporting documents under the social security number of the primary owner and the total will be reported to the IRS under that social security number. This also will affect married or separated taxpayers who do not file jointly. When responding to the IRS notice, you will need to provide the names, addresses and social security numbers of the other owners and a statement to the fact that they each reported their appropriate share.

The foregoing are just a few of the more common examples of computer mismatches that can cause computer generated notices. Even though the IRS feels the notices are readily understandable, experience has show that taxpayer can become confused and that the experienced eye of a tax professional is usually required to decipher the notices. That is why we highly recommend that this office review them prior to you taking any action or responding.

A Word of Caution – The IRS routinely provides state tax agencies with the results of the correspondence audits. Generally, the results of the correspondence audit will need to be dealt with on the state level through an amended state return or wait to receive the state notice. However, if you wait for the state notice, additional interest and penalties may possibly accrue for the state return.