Receiving a Notice of Deficiency can be stressful, but it’s an important part of how the IRS collects taxes and gives you a chance to resolve any issues.
In this guide, we’ll explain what a Notice of Deficiency is, why you might receive one, what it includes, and what steps you can take to respond.
What is a Notice of Deficiency?
A Notice of Deficiency is an official document from the IRS saying that they believe you owe more taxes than you reported. It’s also known as a “90-day letter” because you have 90 days to either pay the extra tax or challenge the IRS’s decision by filing a petition with the U.S. Tax Court if you think they’re wrong.
Key Details:
- Authority to Assess – The Notice allows the IRS to legally assess the tax amount they believe you owe, which could result in collection actions if ignored.
- Legal Rights – This notice is a taxpayer’s last opportunity to contest an IRS determination in court without first paying the amount due.
- Not an Audit Notice – A Notice of Deficiency usually follows an audit but is not the same as an audit notification. It is a final determination based on existing audit findings or other review processes.
Why Did I Receive a Notice of Deficiency?
A Notice of Deficiency can come up in several situations, all suggesting that the IRS thinks there’s an error in your tax filing. Common reasons are:
- Unreported Income – If income reported to the IRS by third parties (such as W-2s or 1099s) doesn’t match the amounts you reported.
- Disallowed Deductions or Credits – Excessive or unsupported claims for deductions or credits (like the Earned Income Tax Credit) tend to trigger a Notice.
- Errors from Audits – If you’ve been audited and the IRS adjusts your tax due based on findings, the final assessment comes in the form of a Notice.
- Mathematical or Clerical Errors – Even small, repeated mistakes can catch the IRS’s attention and might lead to a deficiency notice.
What’s in a Notice of Deficiency?
The notice will outline the IRS’s findings in detail, so it’s important to read it carefully. Key sections include:
- Tax Year(s) in Question – Indicates which year(s) the notice applies to.
- Explanation of Adjustments – Details each adjustment the IRS made to your return and the reasoning behind it.
- Amount Due – The total tax deficiency, including any additional penalties and interest calculated up to the date of the notice.
- Deadline to Respond – You have exactly 90 days (150 days if sent internationally) from the date listed on the notice to file a petition with the U.S. Tax Court if you disagree.
- IRS Contact Information – Includes contact information for the office handling your case, where you can request clarification or provide additional documentation.
Understanding the Consequences of Ignoring a Notice of Deficiency
Ignoring a Notice of Deficiency can have serious consequences. After the 90-day period:
- IRS Assessment and Collection – The IRS will officially assess the tax as due, allowing them to initiate collection actions, such as liens or wage garnishments.
- Increased Penalties and Interest – Penalties for nonpayment and interest will continue to accrue until the tax is paid in full. If the deficiency involves serious negligence or fraud, additional penalties apply.
- Loss of Appeal Rights – If you don’t file a Tax Court petition within the 90-day period, you waive your right to contest the amount without first paying it.
Your Options: Responding to a Notice of Deficiency
It’s important to know your options to respond properly. Here are the steps to consider:
Option 1: Agree and Pay
If you agree with the IRS’s findings, you can simply pay the amount due. Payment can be made in a lump sum or by arranging an installment plan.
- Paying the Full Amount – This is the simplest option if you can afford it, stopping interest and penalties from further accrual.
- Installment Agreements – If you cannot pay in full, you may apply for a payment plan. The IRS offers several options, including short-term and long-term installment agreements.
Option 2: Dispute Through U.S. Tax Court
If you disagree with the IRS’s assessment, you can file a petition with the U.S. Tax Court within 90 days. Filing a petition stops the IRS from proceeding with collections while your case is pending.
- Filing a Petition – Requires submitting a petition form with an explanation of why you disagree with the assessment. You can file on your own or seek legal representation.
- Proving Your Case – To succeed, you’ll need documentation that supports your original return, such as receipts, W-2s, 1099s, or records of deductions and expenses.
Option 3: Submit Additional Information Directly to the IRS
If you believe the notice is based on incorrect or incomplete information, you can provide additional documentation to the IRS. For example, if income was misreported or deductions were denied due to missing paperwork, sending relevant documents might resolve the discrepancy.
- Requesting a Reconsideration – Include copies of supporting documents along with a letter explaining why the initial assessment was incorrect.
- Follow-Up – Regularly check on your submission, as processing times can vary. Keep records of all communications.
What Are Possible Penalties and Interest?
If you owe additional tax, you’ll also face penalties and interest. Knowing how these charges work can help you reduce them.
- Interest – Calculated daily on unpaid amounts, interest accrues from the original due date until the balance is paid.
- Late Payment Penalty – If you delay paying after the 90-day period, a late payment penalty typically applies. This is a percentage of the tax owed and accrues monthly.
- Accuracy-Related Penalty – If underpayment was due to negligence, a substantial understatement, or other serious factors, an accuracy-related penalty of up to 20% could apply.
- Fraud Penalty – In cases of tax fraud, the penalty can be as high as 75% of the underreported tax.
Appealing a Notice of Deficiency Through the IRS Office of Appeals
The IRS Office of Appeals offers an independent review of your case, which can be a more accessible and less formal process than Tax Court.
- Filing an Appeal – If you believe you have a valid argument or evidence, you can submit a formal protest. This appeal must be filed before paying the tax.
- Types of Issues Appealed – Appeals typically address areas that are open to interpretation, like business deductions, fair market values, and specific credits.
- Outcome – Appeals can result in a reduction of the deficiency, agreement on a settlement, or a resolution without going to Tax Court.
Avoiding Future Notices of Deficiency
Although there’s no guaranteed way to avoid an IRS notice, taking a few steps can lower the chances:
- Verify Income Records – Make sure all reported income matches W-2s, 1099s, or any third-party records sent to the IRS.
- Keep Organized Records – Maintaining detailed, accurate records of expenses, deductions, and credits reduces the risk of discrepancies.
- Stay Updated on Tax Law – Tax laws can change, meaning deductions or credits that work one year might not be available the next. Stay informed about IRS updates, especially regarding important tax events or transactions.
- Use a Tax Professional – For complex returns, hiring a tax professional can minimize errors, ensure compliance, and help you avoid red flags.
Seek Professional Help if Needed
Dealing with a Notice of Deficiency can be tough, and tax laws can be complicated. Getting help from tax professionals, such as CPAs, enrolled agents, or tax attorneys, can really help you navigate the process.
- Representation – A tax professional can represent you in dealings with the IRS, simplifying communication and ensuring compliance with deadlines.
- Tax Court Guidance – Tax professionals who are qualified to practice in Tax Court can provide representation if you decide to file a petition.
Conclusion
A Notice of Deficiency can feel overwhelming, but knowing your options can help you respond properly. Collecting the necessary documents and considering professional help can help you handle the situation better, protect your rights, and work toward the best possible outcome.
