I got an IRS Notice of Deficiency. What should I do?

July, 11 2019 by Jean Lee Scherkey, EA

After a long day at the grind, you are home and looking forward to escaping into your favorite TV show for the evening. Quickly, you glance at the mail and time suddenly stops. No, it wasn’t the spicy lunch special you had earlier in the day. With the sound of your heartbeat echoing in your ears like a train roaring down the tracks, you stare at the Notification of Attempted Delivery. At the post office waiting for your signature is a letter from the IRS. Your primal instincts kick-in and you decide that the best course of action would be to bury the notification in the stack of grocery circulars. After all, a letter from the IRS is like getting an invitation to the dance from Penny Wise. If you never “received” the notification, how can the IRS possibly hold you accountable to its contents? If only life and the IRS were this easy. Don’t let the fear of Penny Wise make you dollar foolish by ignoring the IRS! 
 
When getting ready to determine the additional tax on a return that was already filed, the IRS will send, via certified mail, a Notice of Deficiency letter. A Notice of Deficiency, also known as a Statutory Notice of Deficiency, Stat Notice, or 90-day letter, is the final notification a taxpayer will receive before the IRS makes its final assessment of tax due. The letter lets the taxpayer know how much additional tax the IRS is proposing and why. The good news (and yes, there is good news) is that this is not a bill. Instead of viewing the notice as your worst tax nightmare, think of it as an invitation to present your case as to why you do not owe the proposed tax before the IRS makes its final assessment. 
 
The first thing you want to do is review the reason why the IRS is proposing additional tax. One of the common reasons why the IRS issues a Notice of Deficiency is because income that was reported to them by a third party, like an employer or bank, was not included on the submitted return. You want to compare the information in the letter with your tax return. If it looks like the notice is correct and you inadvertently omitted income on your return or entered the amount incorrectly, you will want to let the IRS know you agree with the proposed assessment. Included with the Notice of Deficiency is Form 5564, Notice of Deficiency - Waiver. This form notifies the IRS that you agree with the proposed additional tax due. Sign and return Form 5564, certified with a return receipt requested, as soon as possible to limit the amount of interest that accrues on the balance due. Since the tax was supposed to be paid by the due date of the return, usually April 15th, interest will be added to the balance due. Generally, interest cannot be reduced or removed as it is required to be charged by law. Once the IRS receives the completed form, they will send you a bill for the additional tax due, which will include interest and possibly a penalty or two. Happily, certain penalties can be waived. For more information on how to reduce or remove penalties, please click here. To reduce the amount of interest further, you may send a check for the tax due along with Form 5564. If you are unable to pay the balance due, the IRS offers various payment options. To review these options, please click here. If you only partially agree with the notice, do not fill out Form 5564. This form should only be filled out and submitted when the taxpayer fully agrees with the additional tax due. 
 
What happens if you partially or completely disagree with the proposed additional tax due? The IRS gives taxpayers 90 days (150 days if the taxpayer lives outside of the U.S.) from the notice date listed in the top right corner of the first page of the letter to try to resolve the matter. Keep in mind that there are no extensions to the 90-day window. If you still have between 60 and 90 days before the 90-day period is up, you may want to submit a letter to the IRS stating why you disagree with the notice. Include with your response copies of any documentation that supports your position. It is important to submit copies and not originals as the documentation will not be returned. As with all correspondence sent to the IRS, it is best to send it certified with a return receipt requested.  
 
If you have not been able to resolve the matter with the IRS and the 90-day window is close to expiring, you will want to submit a petition to Tax Court. The petition can be downloaded by clicking here. There is a non-refundable fee of $60 that must be submitted with the petition. However, the fee may be waived if you are unable to pay. To see if you qualify for the Waiver of Filing Fee, please click here. Once your timely petition is received, the Tax Court will send you a Notice of Receipt of Petition that will list your docket number. While you are waiting for your day in Tax Court, you will have the opportunity to resolve the matter through the pre-trial appeals process. One of the biggest benefits to petitioning Tax Court is you do not have to pay the proposed tax before you petition. However, if you are concerned about the amount of interest accruing, you can post a bond called a “6603 Deposit.” It is important to write the check out to the “U.S. Treasury” and to designate the payment as a “6603 Deposit.” Any payments without this designation will be interpreted as agreeing with the proposed assessment. For more information on how to send a 6603 Deposit, please click here. 
 
If the 90-day window passes without resolving the issue or filing a petition to Tax Court, the IRS will assess the tax, send a bill to the taxpayer, and start the collection process. Fear not, for all is not lost! In addition to possibly filing an appeal through the IRS Appeals Office, you can:

• Request an Audit Reconsideration, 
• Pay the amount of tax due and then file a formal claim for refund by submitting a Form 1040X, Amended U.S. Individual Income Tax Return, or 
• Pay the balance due and then file a suit for refund in the United States District Court or United States Court of Federal Claims. 

Receiving a notice from the IRS is never fun and, in fact, it can be scarier than a room full of laughing clowns in a fun house. The worst thing you can do is freeze and do nothing. By being proactive, you are making sure you only pay what’s rightfully due.