IRS Notices: What They Mean and What to Do Next
By Cody Heimerdinger, CPA, Director
Few pieces of mail get someone’s attention faster than an envelope from the Internal Revenue Service. The instinctive reaction is understandable: How much do I owe? What did I do wrong? Is this an audit? Do I need to pay this immediately? But those are not always the first questions that should be asked. The first question should be much simpler:
What, exactly, is the IRS telling me?
An IRS notice can mean many different things. The Service may be asking for information, proposing a change, notifying you of an assessment, attempting to collect an existing balance, or starting a deadline that affects your right to challenge its position. Those are very different procedural situations, and they can require very different responses. The amount printed in bold on the first page may grab your attention. But in many cases, the notice type, tax year, issue, and response deadline are more important than the dollar amount itself.
Not Every IRS Notice Is an Audit – or Even a Bill
One of the first things I do when reviewing an IRS notice is determine where the taxpayer actually is in the process.
For example, the IRS might identify a difference between a tax return and information reported by a bank, brokerage firm, employer, or other third party. A CP2000 notice commonly arises in this situation.
That does not necessarily mean the IRS has audited the taxpayer and determined that additional tax is owed. Generally, the IRS is proposing an adjustment and giving the taxpayer an opportunity to respond. That distinction matters. If a taxpayer immediately pays a proposed amount without reviewing the underlying issue, they may be paying tax that was never actually due.
On the other hand, a CP14 generally means the IRS believes a liability has already been assessed and remains unpaid. Now the issue may be whether the assessment is correct, whether a payment was misapplied, whether penalties can be reduced, or whether a collection alternative is appropriate. Same agency. Same intimidating envelope.
Completely different problem.
Understand Where You Are in the IRS Process
Most IRS notices can be understood more easily by asking which of the following situations applies.
Is the IRS proposing something?
The IRS may believe income was omitted, a deduction was overstated, or information reported by a third party does not match the tax return. At this stage, the taxpayer may still have an opportunity to explain the discrepancy, provide documentation, and challenge the proposed adjustment before additional tax is assessed.
Has the IRS already assessed something?
The IRS may be notifying the taxpayer of an existing balance consisting of tax, penalties, and interest. Before paying, determine where the balance came from and whether it is correct. Sometimes the answer is straightforward. Other times, a payment was applied incorrectly, an IRS adjustment was wrong, or a penalty may qualify for relief.
Has the account moved into collections?
Notices such as CP501, CP503, and CP504 generally indicate that the IRS is attempting to collect an assessed liability. At this point, the conversation may shift from simply determining the correct tax to addressing how the liability will be resolved. Depending on the circumstances, that could involve payment arrangements, penalty relief, collection alternatives, or procedural rights relating to IRS enforcement activity.
Has a statutory deadline started running?
This is where an IRS notice can become particularly important. A Statutory Notice of Deficiency, commonly called a “90-day letter”, generally provides 90 days to petition the U.S. Tax Court before the IRS can assess the proposed deficiency. Certain collection notices can carry important hearing rights.
Notices denying refund claims can begin separate statutory periods for pursuing those claims in court. These deadlines should not be treated like ordinary response dates. A taxpayer can have an excellent substantive tax position and still lose an important procedural remedy by missing the applicable deadline.
The Date on the Notice May Matter More Than the Amount
This is one of the most important practical lessons in IRS controversy. A taxpayer may receive a notice showing $100,000 of proposed additional tax and immediately focus on whether that number is right or wrong. That question certainly matters. But first ask:
When do we have to act, and what happens if we do not?
- Some deadlines merely affect the efficiency of resolving an issue. Others can determine whether a taxpayer retains the right to go to Appeals, request a hearing, petition Tax Court, or pursue a refund through the courts. Continuing to speak with an IRS employee does not necessarily suspend one of those statutory deadlines. That is why important IRS correspondence should be reviewed promptly, even when the taxpayer believes the notice is obviously incorrect.
Build the Response Around the IRS Question:
- Once the issue and procedural posture are understood, the next step is building the response. More documentation is not always better. A common mistake is sending the IRS a large collection of records with little explanation and expecting the examiner or IRS employee to figure out why everything matters. A stronger approach is to build the response around the specific issue the IRS raised.
If the IRS asks three questions, make it easy to identify:
- The IRS question;
- The taxpayer’s answer;
- The supporting documentation; and
- Why that documentation supports the taxpayer’s position.
Supporting documents should be labeled and organized. A concise cover letter should explain what is being provided and why. The objective is not to overwhelm the IRS with paper. The objective is to make the taxpayer’s position easy to understand and difficult to misunderstand.
Keep the Proof That You Responded
There is another part of IRS correspondence that receives far less attention than it should: proving the response was actually submitted. Whenever documents are sent to the IRS, retain evidence of the submission. That may include certified mail records, approved private delivery tracking, fax confirmations, electronic submission confirmations, and complete copies of everything provided. Months later, if the IRS says it never received the response, that transmission record can become extremely important. In IRS controversy work, the fax confirmation may be the least impressive document in the file, right up until the day it becomes the most important one.
A Few Mistakes That Can Make Matters Worse
When taxpayers receive an IRS notice, several natural reactions can create unnecessary problems.
- Paying immediately without understanding the adjustment can result in paying an incorrect liability.
- Ignoring a notice because “the IRS is wrong” does not prevent the IRS process from continuing.
- Waiting until the final few days can make it difficult to gather records and prepare a thoughtful response.
- Sending boxes of unorganized documents can create more questions rather than fewer.
- And perhaps most importantly, focusing exclusively on the underlying tax dispute can cause a taxpayer to miss the procedural deadline controlling how that dispute must be raised.
Responding to the IRS is not simply about proving who is right. It is about proving the taxpayer’s position at the right time, through the right process, with the right documentation.
The Bigger Lesson
IRS notices are designed to communicate very specific things, but to taxpayers they can all look remarkably similar. That is why the first step should rarely be writing a check or firing off a response.
Instead, identify:
- What tax year is involved?
- What issue is the IRS raising?
- Is the adjustment proposed or already assessed?
- What deadline applies?
- What rights are preserved (…or potentially lost) when that deadline passes?
- What evidence supports the taxpayer’s position?
Once those questions are answered, the path forward usually becomes much clearer. An IRS notice does not automatically mean the IRS is correct, and it does not necessarily mean the taxpayer is headed for an audit or collection action. But it does mean the correspondence deserves attention.
Received an IRS Notice?
If you receive correspondence from the IRS and are unsure what it means, do not ignore it, and do not assume the amount shown is automatically correct. Keystone CPAs assists taxpayers with IRS notices, examinations, appeals, penalty matters, collection issues, and other federal tax controversies. The earlier we can determine what the IRS is asking, identify the applicable deadline, and evaluate the underlying tax issue, the more options we generally have to work toward the right resolution.
Sometimes the most important part of responding to an IRS notice is not answering the IRS’s question. It is knowing which question needs to be answered first.