In the land of the IRS, which is nowhere near as appealing as the Land of Oz, much of the correspondence sent to taxpayers implicates a significant taxpayer right that can only be exercised on time. Taxpayers who are afraid to open IRS mail and therefore delay doing so – or even worse, never do – waive important rights that, if exercised on time, provide taxpayer protections and may possibly result in a favorable outcome for the taxpayer. By understanding what kinds of letters are issued during the course of an IRS examination and what rights they trigger, taxpayers can avoid waiving those important rights.
For individuals, IRS examinations typically fall into three categories right now:
- Routine IRS correspondence examinations;
- Face to face IRS examinations; and
- High Net Worth IRS examinations.
IRS Examination Notices
The first notice taxpayers receive in an IRS exam is usually the notification that the taxpayer has been selected for examination. Once the examination is underway, the IRS will start communicating regarding what the issues in dispute are and what additional information the IRS wants to verify on the tax returns. This is typically communicated through an Information Document Request, or IDR.
Information Document Requests (“IDRs”)
A typical IDR example from a correspondence exam would be a request for proof of a charitable contribution for which the taxpayer took a deduction. Here’s a good example of a response to an IDR:
Jane Q. Taxpayer
August 27, 2020
IRS Exam Unit
Re: IDR #1
Dear Edmond IRS Examiner:
I received your letter dated August 1, 2020, requesting information from my 2018 tax return. Pursuant to your request, I have enclosed the following:
Request One: Proof of charitable contributions for the year 2018
- Receipt for the March of Dimes charitable contribution for the year 2018
- Receipt for the American Cancer Society charitable contribution for the year 2018
- Receipt for the donation of goods to local food pantry
Request Two: Proof of mileage for Schedule C business, Jane’s Q Tips
Enclosed: mileage log for the year 2018
Why bother repeating everything the IRS asked for and then say what you are giving them? Because in general, if the IRS does not agree with the taxpayer and decides additional tax is due, when a taxpayer contests the additional tax in United States Tax Court (or any other court), the IRS determination is presumed to be correct.
But wait, you might be thinking, I thought I was innocent until proven guilty?! That is true in criminal matters; someone who is accused of a crime is innocent until proven guilty and the government has the burden to prove otherwise. However, in civil tax matters, the IRS is presumed to be correct, unless the taxpayer can shift the burden of proof to the IRS. The only way to do so is to (1) respond to each and every legitimate IDR request for information from the IRS, (2) on time, and (3) in full. If the taxpayer can demonstrate compliance with all reasonable requests for information during the IRS exam, then the taxpayer has satisfied the first and most important step in shifting the burden of proof to the IRS in court. (And, as a tax controversy and tax litigation attorney, in my experience timely, complete, and organized responses to IDRs are also the best way to resolve an IRS exam without litigation at all).
Of course, if the IRS issues an IDR requesting documents that do not exist, are protected by attorney-client privilege or another privilege, or documents that the taxpayer simply does not have, a taxpayer need not produce them (and certainly need not create documents that do not exist) in order to satisfy this requirement. When in doubt, consult with a qualified tax professional on these kinds of questions.
The most important rule to keep in mind when responding to IDRs and any IRS request for information is to be truthful. Anyone who impedes, obstructs, or frustrates an IRS examination risks not only being assessed additional tax at the end of the IRS audit, but also being charged with a felony. Watergate’s famous lesson – “It’s not the crime, it’s the cover-up” is particularly apt here. If you claimed a deduction you shouldn’t have, failed to claim income you should have, or simply made a genuine mistake on your tax return, those issues can often be resolved without a referral to the IRS Criminal Investigation Unit. But providing false, misleading, or otherwise inaccurate information during the course of an IRS examination will only make things worse.
Finally, taxpayers who need additional time to gather and produce the requested information can typically get an extension, but simply ignoring an IDR deadline will result in not being able to shift the burden of proof at best, and having the disputed issue disallowed entirely by the IRS at worst. Once the IDR process is complete and the Revenue Agent has determined what, if any, additional tax is due, additional important notices and rights are triggered.
Notice of Proposed Adjustment (“NOPA”)
The Notice of Proposed Adjustment, or NOPA, tells the taxpayer exactly what items the examiner disagrees with from the tax return, what adjustments the examiner proposes should be made, and what the additional tax and, if applicable, penalties should be assessed. When a NOPA is issued the taxpayer typically has 30 days to file a “protest” and request a hearing at IRS Appeals. IRS Appeals will only take a case if there is at least one year remaining on the statute of limitations to assess tax, so often a taxpayer must sign a consent to extend the period of time in which the IRS may assess tax to go to IRS Appeals. IRS Appeals is not court – it is an independent division of the IRS. An IRS Appeals agent will hear from the IRS exam agent and from the taxpayer and make a recommendation on how to proceed. IRS Appeals agents cannot consider issues raised for the first time at Appeals, making responding to IDRs at IRS exam even more important. The 30 day deadline to file a protest after a NOPA is issued may be extended by agreement. To request an extension, speak with the Revenue Agent or Exam Agent who issued the NOPA and request an extension of time to respond. Always follow up with a written confirmation of agreement to the extension.
Notice of Deficiency
A Notice of Deficiency is the most important document in an IRS Examination. When a Notice of Deficiency is issued, the IRS has finished the exam and has “determined” what additional tax is due and, if applicable, penalties. Once a Notice of Deficiency is issued, a taxpayer has 90 days to file a petition in Tax Court. The 90 day deadline cannot be extended by anyone, for any reason. Only an act of Congress, such as the extension provided as a response to the COVID-19 outbreak, can extend the amount of time to file a Tax Court petition. What happens if the petition is late? Disaster. If a taxpayer does not file a Tax Court petition within 90 days of the day a Notice of Deficiency is issued, then the IRS will assess the complete amount of tax, penalties and interest in the Notice of Deficiency. The taxpayer’s only method of disputing the tax now is to pay the tax, penalties and interest in full, file a claim for refund with the IRS, and if the IRS does not grant the request, file a lawsuit in United States District Court or the United States Court of Federal Claims. What’s so wrong with that? Lots of things. The United States Tax Court is the only court where taxpayers can dispute the IRS’s determination before paying the disputed tax. Not only that, but the cost of litigation in Tax Court is significantly lower than the cost of litigating in Federal District Court or the United States Court of Federal Claims.
Taxpayers who received a Notice of Deficiency, want to contest the tax in Tax Court, but cannot afford a lawyer may qualify for free legal representation through one of the many Low Income Taxpayer Clinics located around the country. Highly qualified attorneys who are on staff and volunteer through these organizations can assist you in working to resolve or try your case.
No matter what, don’t just bury your head in the sand.