How to Respond to an IRS Soft Notice
An IRS soft notice is an inquiry, not an audit. Our guide provides a clear framework for gathering information and formulating an effective response.
Receiving a notice from the Internal Revenue Service can be concerning, but a “soft notice” is not a cause for alarm. Unlike a formal audit or a tax bill, a soft notice is an initial inquiry. Its purpose is to encourage voluntary compliance when the IRS’s automated systems find a potential mismatch between your tax return and data received from third parties.
A soft notice points out a possible discrepancy and asks you to review your return. It is not a formal assessment of tax, a demand for payment, or the start of an official audit. Instead, it is an opportunity to correct a potential error or provide an explanation if you believe your return is correct.
Purpose and Common Types of Soft Notices
The IRS uses soft notices to address potential compliance issues without launching a full-scale examination. These letters are triggered by automated programs that compare your Form 1040 with information filed by third parties like employers or banks. The goal is to prompt taxpayers to self-correct any identified discrepancies.
One common soft notice relates to virtual currency transactions. Letters 6173, 6174, and 6174-A are sent to taxpayers who the IRS believes may have failed to report transactions involving cryptocurrency. Since the IRS requires an answer on Form 1040 about virtual currency activities, an omission can be flagged. These notices remind taxpayers of their reporting obligations and urge them to amend returns for unreported transactions.
Another frequent soft notice is the CP2057, which addresses mismatches related to Form 1099-K, “Payment Card and Third Party Network Transactions.” This form is issued by payment settlement entities to report the gross amount of transactions. A CP2057 notice is generated when the gross income on the 1099-K does not align with the income on the tax return. This can happen if a business owner reports net income after expenses, while the 1099-K shows the unadjusted gross total.
The IRS also issues soft notices concerning the Affordable Care Act (ACA). These letters may inquire about missing information on health insurance coverage or discrepancies in the premium tax credit calculation. For example, if a taxpayer received advance payments of the premium tax credit, the IRS matches information from Form 1095-A with the taxpayer’s Form 8962. Any inconsistencies can trigger a notice asking for clarification.
Information to Gather for Your Response
Before responding to an IRS soft notice, you must gather and organize all relevant documentation. The specific documents you need will depend on the type of notice you received. This step is necessary to determine whether you agree or disagree with the IRS’s inquiry.
For a virtual currency notice, such as Letter 6173, compile a record of all your cryptocurrency activities for the tax year. This includes detailed transaction histories from every exchange you used. You must also prepare cost basis calculations for every disposal of virtual currency, documenting the original purchase price and fees to determine the capital gain or loss. If you received cryptocurrency as income, you need records showing its fair market value at the time of receipt.
If you received a Form 1099-K notice like the CP2057, you must reconcile the gross amount on the form with the income you reported. Gather your bank deposit records, merchant processing statements, and accounting software reports. These documents can help demonstrate how you arrived at your reported net income. Also collect receipts for business expenses, customer refunds, and processing fees that were deducted from the gross transaction volume.
For notices related to the Affordable Care Act, the key documents are your health coverage forms. Locate your Form 1095-A, Form 1095-B, or Form 1095-C. You should also gather proof of health coverage for yourself and any dependents, along with the records you used to calculate your premium tax credit on Form 8962. These documents are necessary to verify your eligibility and the accuracy of your calculations.
How to Formulate and Submit a Response
Once you have gathered your information and reviewed your tax return, you must decide how to respond. There are two paths: agreeing or disagreeing with the notice. It is important to act promptly, as the notice will specify a deadline for your response.
If your review confirms that your original tax return was incorrect, the response is to file an amended return. Use Form 1040-X, “Amended U.S. Individual Income Tax Return,” to correct the error. On this form, you will report the corrected figures and provide a brief explanation of the changes.
If you conclude that your original tax return is accurate, prepare a written explanation disagreeing with the notice. At the top, include your full name, Social Security Number, the notice number, and the tax year. In the body of the letter, state that you disagree and explain why, referencing the specific supporting documents you have gathered. Do not send original documents; always send copies.
Whether submitting an amended return or a letter of explanation, send your response package using USPS Certified Mail with Return Receipt. This provides a record of when you mailed the response and proof of receipt. Use the address provided on the notice for your correspondence. If your response is accepted, the IRS will send a confirmation letter; if not, the issue could be escalated to a more formal inquiry.