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The IRS is relying more on automated systems, and the number of IRS and state examinations has increased. CLA Partner Andy Biebl explains what taxpayers need to understand this environment, and know what to do when a notice appears.


Dealing With Those IRS Notices

  • 3/8/2012

It’s becoming a less friendly world these days in terms of the volume of notices and assessments taxpayers are receiving from the IRS and state tax agencies.

“The IRS is relying more on automated systems, and the number of IRS and state examinations has increased,” notes Andy Biebl, a tax partner with CliftonLarsonAllen. “Our clients need to understand this harsher environment, and know what to do when a notice does appear.”

Growing IRS automation

The recently-released National Taxpayer Advocate’s 2011 Annual Report to Congress notes that the IRS is increasingly relying on automated data-matching procedures to identify possible tax return errors and make tax adjustments. The IRS is then issuing assessments to taxpayers based on these automated results about errors in their tax return.

“These IRS matching notices seem to be wrong more often than right,” says Biebl. “And when these notices do arrive, there is no polite inquiry — just an assessment of tax on the assumption that the IRS computer is right.”

The report says the IRS workload has grown dramatically in recent years, due to the increasing complexity of the Internal Revenue Code. The code is approaching 4 million words and had an estimated 579 changes to the law within 2010 alone. To handle this rising workload, the IRS is relying more on automated data-matching procedures that generate tax notices to individuals.

“Most of these notices are untouched by human hands,” says Bob Gibson, a private client tax partner at CliftonLarsonAllen. “They are entirely computer-generated, and taxpayers may receive a notice stating their return was incorrect simply because the IRS computer did not spot an item reported properly elsewhere within the return.”

More 1099s and state exams

Congress has added to the problem by expanding the array of 1099 information returns. For instance, there is new cost data on securities sales, and business gross receipts reporting from credit card companies for the 2011 tax year.

“We’re also seeing a big increase in state income tax examinations,” adds Biebl. “Most states are strapped for cash, and there is increased examination activity in areas that previously were only touched by IRS auditors.”

Tips for taxpayers

Biebl offers suggestions below for taxpayers who receive IRS or state notices.

What to do

  • Contact your tax professional. Any IRS or state tax communication needs to be sent to your CliftonLarsonAllen tax advisor as soon as possible. These notices often have time-critical deadlines, and the appropriate response may depend on details within your return that are not easily deciphered. “This is not a place to save a little money by trying to do it yourself,” advises Gibson. “Even the simplest of IRS communications should be sent to your tax advisor immediately, because there can be consequences that aren’t apparent if you are not familiar with the tax law.” Timeliness is also critical; missing a deadline in some of these notices can require an expensive United States Tax Court petition, instead of a mere letter to the IRS.
  • Capture all 1099 and other third party tax documents. W-2, 1099, K-1, and other tax reports typically are sent to taxpayers in the first months of the tax year, but they can appear at any time. Capture all of those documents, and make sure that they are part of your package provided to CliftonLarsonAllen at tax preparation time. If you are unsure whether a document is an official 1099 (some institutions use letterhead to issue “substitute” 1099s), send it to your CliftonLarsonAllen tax advisor and we will sort it out.

What not to do

  • Pay the IRS or state, unless directed by your tax advisor. An erroneous payment in response to an IRS or state notice can take months of correspondence and documentation to retrieve.
  • Call, write, or meet an IRS or state examiner on your own. An aggressive tax examiner who knows the law can use a casual description from a taxpayer to cast a transaction in an unfavorable manner. “All it takes is the wrong adjective, and the exam can turn out very badly,” warns Biebl. For example, describing your 20 percent ownership in a partnership as an investment rather than a business could dramatically change the tax status of a loss from the entity, at least in the eyes of an examiner looking for a quick adjustment to a tax return, according to Biebl.
  • Assume the IRS notice is right. As the National Taxpayer Advocate report stated, these computerized assessments are inherently imperfect and the taxpayer’s return is often correct as filed. “If your tax advisor saw all of your 1099s and other data when preparing your tax return, the odds are very high that your return is correct and the notice has overlooked some details,” says Gibson.

How we can help

No matter how small or innocent that communication from the IRS or state tax department appears to be, it is critical that your CliftonLarsonAllen tax professional has an opportunity to give it a quick review. Even if the adjustment appears to be small, there can be significant hidden implications. For example, a state tax adjustment will subsequently be reported to the IRS, where the tax consequences can be substantially greater. Your CliftonLarsonAllen tax advisor can help you interpret those IRS or state tax communication and respond appropriately.