Decoding IRS "Love Letters": What to Do When the Taxman Writes

Issue# 1121

Ah, springtime. Birds are chirping, flowers are blooming, and… the mailbox brings a crisp, official-looking envelope from our favorite pen pal in Washington D.C. Yes, it's that special time of year when the IRS decides to reach out and touch base. While these missives might not be filled with hearts and XOXO's, understanding them is crucial to avoid any real heartbreak down the line. So, grab a cup of coffee, take a deep breath, and let's decode these so-called "love letters" from the taxman.

Receiving

Receiving mail from the IRS can be unsettling. It's easy to panic, but most of these "love letters," as they're sometimes called, are simply automated notices generated by computers. The key is to stay calm and understand how to respond. Here's a breakdown of what to do:

• Don't panic! Most letters are routine.

• Check the date: IRS notices are time-sensitive. Note the response deadline.  

• Identify the period: Know which tax return and year the letter concerns.

• Read the letter carefully: It explains why the IRS contacted you (e.g., unreported income, discrepancies, or unpaid taxes).

• Have your return handy: Keep a copy of your tax return and the notice nearby if you need to call the IRS.

• Respond promptly: Contact the IRS or share the notice with your tax preparer before the deadline.

It's worth noting that the IRS is increasing its enforcement efforts. As part of the Inflation Reduction Act passed in May 2024, the IRS received a significant boost in funding, with about half of the allocated $80 billion earmarked for enforcement. While the IRS has stated that increased audits will not target small businesses and individuals making under $400,000 annually, overall audit rates are expected to rise from their current all-time low.

While taxpayers with "large, unusual or questionable items" on their returns may be singled out, statistics indicate that individuals are audited more frequently than businesses. In 2017, the audit rate for all taxpayers was about 0.542%, while for individual returns (Form 1040), it was around 0.623%. Corporations and partnerships faced lower audit rates.

The IRS tends to focus its audit resources on areas with a history of non-compliance, such as international taxpayers, high-wealth individuals (with gross income over $1 million), and sole proprietors or single-member LLCs grossing over $100,000. Traditional wage earners with traceable income reported on W-2 forms face less scrutiny.  

Beyond audits, the IRS also uses automated matching programs to check for discrepancies between tax returns and information they receive from other sources (like W-2s and 1099s). You are significantly more likely to receive a notice from the IRS due to these matching programs than from a formal audit.  

Whether it's an audit or a notice from a matching program, these inquiries can be costly. IRS data from audits shows that over 90% result in a tax change, with the average additional tax owed ranging from around $6,000 for mail audits to nearly $22,000 for field audits. Matching program notices also resulted in an average of about $2,000 in additional tax collected per notice in 2017. Additionally, accuracy penalties can add 20% to the tax bill.  

For most taxpayers, the best way to avoid IRS scrutiny is to ensure all wage and income documents are accurately reported on their tax return. Providing your tax preparer with all necessary documents is crucial, as they rely on this information to file correctly.

Remember, prompt action is crucial when you receive an IRS letter. By understanding what the letter means and how to respond, you can resolve any issues efficiently.

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Disclaimer: This blog post is for informational purposes only and does not constitute legal, financial, or medical advice. It is not a recommendation for any specific action. Families should consult qualified professionals to understand how potential policy changes may apply to their unique circumstances.