Getting IRS Notices and Tax Audits

Tax audits appear to have reached an all-time high. After years of struggling with tackling an insurmountable amount of information to process, technological advances now make tackling the underreporting of taxable income easier than ever and can be accomplished quite efficiently by the Internal Revenue Service (IRS).

The methods most commonly used by the IRS in auditing, or examining, tax returns have drastically changed. While the IRS still conducts face-to-face meetings, its compliance strategy for the 21^st century is shifting. In the 1990s, the IRS approached compliance through traditional methods such as audits and in-person collection.

"Did you get an IRS Notice or Letter in the mail and think you're not being audited? Think again."

During the past 10 years, the IRS has improved its ability to target potential non-compliance through technology. More IRS Notices are going out to taxpayer than ever before. Since 2001, the notice volume has increase 670 percent, to 201 million sent in 2009.

The IRS has reported the following results:

• For the more than 4.3 million information '"matching notice discrepancy audits, the average return on investment for the IRS is $1,670 per return, with little involvement by IRS personnel.
• The IRS mail audit program, responsible for 78 percent of all IRS audits in 2010, averages almost $6,600 in additional taxes owed per audit.
• With enhancements in notice and information systems, the IRS also improved its compliance practices and reduced personnel by 6 percent during the past 10 years.

The most commonly used IRS Notice in this area is the CP-2000; Underreported Income Adjustment. This notice is most commonly used where third parties, such as banks, brokerage firms and employers, have reported taxable income that differs from that reported by taxpayers on their individual federal income tax returns.

There are other notices as well such as:

• CP23/24 Estimated Tax Discrepancies '" Notices addressing discrepancies in estimated payments
• CP14 Balance Due '" Notice indicating that tax return payments are owed
• CP88 Refund Hold Due to Missing Tax Return

If you receive a letter or notice from the IRS, the first thing to do is not ignore the notice. Unfortunately, ignoring or not reading this notice is the most common action found by taxpayers. Even after reading the Notice, most taxpayers don't understand what the Notice is about, or exactly what to do, despite numerous efforts by the IRS to make their notices or letters easier to read and understandable.

The CP-2000; Underreported Income Adjustment details:

• what was reported to the IRS that appears to not have been included on the taxpayer's individual income tax return
• what the IRS proposes the changes would be if the item of income was properly reported
• what the additional tax is as a result of the proposed change

Sometimes, after reading the notice, taxpayers conclude that the notice is correct '" that they underreported the taxable income and that they owe taxes on what they failed to report. Other times, the IRS is just plain wrong!

The most common error reflected by the IRS is where a taxpayer liquidates, or sells, securities. In these cases, the IRS is usually correct that stocks, or bonds, were sold and never reported, but fails to give the taxpayer any credit for what he paid for those stocks or bonds and assesses tax on the sales proceeds amount. The IRS is very aware of this inherent problem but due to the failure to actually know the cost of the securities sold just assesses tax on the full amount '" leaving it up to the taxpayer to report otherwise.

Other times, due to the complication of the federal tax laws, there are other factors that can mitigate the proposed taxes that may not be considered.

The second most common error is where taxpayers fail to report self-employment income reported on Form 1099-MISC, but fail to report the expenses associated with the earning of these proceeds.

This is where the "do-it-yourself" tax programs unfortunately fall short. An experienced tax preparer can understand, analyze and respond to IRS audit notices, review mitigating factors that may reduce your income taxes where you have underreported or failed to report transactions that may result in additional income. You may even end up getting a refund greater than what you originally reported.

You also have to consider the penalties. Sometimes the additional amounts owed from penalties and interest can be as much, or greater than, the taxes owed. Penalties and interest can sometimes be abated '" that is eliminated, or otherwise reduced, where the taxpayer can establish reasonable cause '" or a qualifying reason that penalties should not apply. You can often get these penalties waived by writing to the IRS and requesting a waiver.

Whatever the outcome is it is important to be proactive and not ignore the notices you receive. Ignore the notices for too long and you can lose certain statutory rights you have to challenge the additional tax assessments in a variety of venues available to you.