How Do I Respond to an IRS Deficiency Notice?

Receiving a deficiency notice from the IRS can be unsettling, but it’s important to address it promptly. This notice means the IRS believes you owe additional taxes based on their review of your return. Ignoring it could lead to penalties or further collection actions.

Handling the situation effectively requires reviewing the details carefully and determining the best course of action.

Confirming the Notice and Deadlines

Before responding, verify the accuracy of the notice. The IRS issues a Notice of Deficiency (Form CP3219A) when it determines a taxpayer has underreported income, miscalculated deductions, or omitted taxable items. This document outlines the proposed changes, the amount owed, and the reasoning behind the adjustment. Reviewing it ensures the issue pertains to your tax return and is not due to an IRS error or identity theft.

The date on the notice is important because it sets the response deadline. Taxpayers have 90 days from the date printed on the letter to either agree with the assessment or challenge it. Missing this deadline eliminates the option to petition the U.S. Tax Court, which allows disputes to be resolved without paying the amount upfront. For those residing outside the U.S., the response period extends to 150 days.

The IRS may have sent prior correspondence before issuing the deficiency notice. Reviewing past communications can clarify whether the issue stems from an unaddressed inquiry or an unresolved audit. If the notice seems unexpected, checking your IRS online account or calling the agency can confirm whether additional notices were sent that may have been lost or overlooked.

Gathering Tax Documentation

Organizing financial records helps determine whether the IRS’s proposed changes are justified. Start by locating a copy of the tax return in question and comparing it with supporting documents such as W-2s, 1099s, bank statements, and receipts for deductible expenses. If the notice involves unreported income, cross-referencing employer or payer records with IRS transcripts can clarify whether an omission or reporting error occurred.

Tax transcripts, available through the IRS’s online portal, provide a breakdown of what was reported to the agency. Wage and income transcripts, account transcripts, and record of account transcripts each offer different details. Comparing these with personal records can confirm whether third-party entities, such as employers or financial institutions, submitted incorrect information. If discrepancies arise, contacting the issuer for a corrected form may be necessary before disputing the IRS’s findings.

If the IRS has disallowed a deduction, gathering invoices, receipts, and relevant contracts can substantiate the claim. For example, if a business expense was denied, maintaining a log of transactions and business purpose explanations can support its validity. Similarly, if a tax credit is questioned, such as the Earned Income Tax Credit or Child Tax Credit, ensuring eligibility requirements were met and providing proof of qualifying dependents can strengthen a case.

Evaluating Response Options

Once all relevant tax records have been reviewed, the next step is deciding how to proceed. The IRS deficiency notice presents three primary options: accepting the proposed changes, filing an amended return, or requesting an appeal.

Accept the Changes

If the IRS’s adjustments are correct, agreeing to the changes is the simplest course of action. This involves signing and returning the notice, finalizing the assessment. Once accepted, the IRS will issue a bill for the amount owed, including any applicable interest and penalties. Interest accrues from the original due date of the return at the federal short-term rate plus 3%, compounded daily. A failure-to-pay penalty of 0.5% per month applies, up to a maximum of 25% of the unpaid balance.

Payment options include full payment, installment agreements, or an Offer in Compromise if financial hardship prevents full repayment. The IRS allows installment plans for balances under $50,000 without requiring extensive financial disclosures. For larger amounts, Form 9465 (Installment Agreement Request) and Form 433-F (Collection Information Statement) may be required. If the balance is unaffordable, an Offer in Compromise, submitted via Form 656, could reduce the total owed based on income, expenses, and asset equity.

Amend Your Filing

If errors were made on the original return but the IRS’s adjustments do not fully account for all necessary corrections, filing an amended return may be appropriate. This is done using Form 1040-X, which allows taxpayers to correct income, deductions, credits, or filing status. An amended return provides an opportunity to claim additional deductions or credits that may offset some of the IRS’s proposed tax increase.

For example, if the IRS identified unreported income but overlooked a corresponding deductible expense, submitting an amended return ensures the correct tax liability is assessed. The IRS generally allows three years from the original filing deadline to amend a return, but submitting Form 1040-X promptly can prevent further interest accrual. Supporting documentation, such as revised W-2s, corrected 1099s, or additional receipts, should be included to substantiate the changes.

Request an Appeal

If the IRS’s findings are incorrect and the proposed tax liability is disputed, requesting an appeal provides an opportunity to challenge the assessment before it becomes final. The IRS Office of Appeals is an independent body that reviews tax disputes and seeks to resolve them without litigation. To initiate an appeal, taxpayers must submit a written protest, typically using Form 12203 (Request for Appeals Review) or a formal letter outlining the disagreement.

The appeal must be filed within the 90-day window specified in the deficiency notice. If unresolved at the administrative level, the case can be taken to the U.S. Tax Court, where taxpayers can contest the deficiency without paying the disputed amount upfront. Common grounds for appeal include misinterpretation of tax law, incorrect application of tax rates, or reliance on inaccurate third-party reporting. Providing clear evidence, such as legal precedents, IRS regulations, or financial records, strengthens the case. If successful, the IRS may reduce or eliminate the additional tax liability.

Submitting Your Response

Once the appropriate course of action has been determined, ensuring the response is properly prepared and delivered is necessary to avoid processing delays or further complications. The IRS requires deficiency notice responses to be submitted in writing, with any supporting documentation clearly labeled and organized to facilitate review. If agreeing with the assessment, signing and returning the notice using the provided instructions is sufficient. If disputing the findings, the response must include a detailed explanation of the disagreement, referencing applicable tax provisions or factual evidence.

When filing an amended return, submitting Form 1040-X along with any corrected or additional records is necessary to substantiate adjustments. Attaching a written explanation clarifies the changes, reducing the likelihood of further inquiries. If requesting an appeal, the submission must outline specific reasons for contesting the deficiency, supported by relevant statutes, IRS regulations, or case law. Providing a structured argument increases the likelihood of a favorable resolution without requiring escalation to tax court.

Maintaining Communication with the IRS

After submitting a response, staying engaged with the IRS ensures the matter is processed correctly and avoids unnecessary complications. The agency may request additional documentation or clarification before finalizing the case. Monitoring correspondence and responding promptly prevents delays that could lead to further penalties or collection actions.

If the IRS does not acknowledge receipt of a response within a reasonable timeframe, checking the status through an IRS representative or the taxpayer’s online account can confirm whether the submission was received and is under review. In cases where an appeal has been filed, the Office of Appeals may schedule a conference to discuss the dispute. Being prepared with relevant records and a clear argument improves the chances of a favorable outcome. If an installment agreement or payment arrangement is necessary, maintaining compliance with agreed terms prevents further enforcement actions, such as liens or levies.