What Should You Do If You Receive IRS Letter 566?

Getting a letter from the IRS can be stressful, especially if it’s about an audit. Letter 566 is sent when the IRS needs more information to verify certain items on your tax return. While this doesn’t necessarily mean you did something wrong, it does require prompt attention to avoid complications.

Handling this correctly means understanding what the IRS is requesting and providing the necessary documentation on time. Ignoring or delaying your response could lead to changes in your tax liability or penalties.

Reasons for Receiving Letter 566

The IRS issues Letter 566 when it selects a tax return for a correspondence audit, meaning it needs additional details to confirm deductions, credits, or income. This review is often triggered by discrepancies between your return and data from employers, banks, or investment firms. If a W-2 or 1099 reports higher income than what was filed, the IRS may request clarification.

Certain deductions and credits receive closer scrutiny, especially if they seem high relative to income. The Earned Income Tax Credit (EITC), Child Tax Credit (CTC), and American Opportunity Credit (AOC) are common areas of focus since they can reduce tax liability or generate refunds. Large charitable contributions, business expenses on a Schedule C, or rental property losses may also prompt an inquiry.

Self-employed individuals and small business owners often receive Letter 566 due to the complexity of their filings. The IRS may request proof for business deductions such as travel, meals, or home office expenses, especially if they seem excessive. Cash-based businesses or those with substantial 1099 income may also face verification requests to ensure all earnings were reported.

Documents to Provide for Verification

The IRS expects clear records to substantiate the items under review. If deductions are questioned, receipts, invoices, and bank statements showing payment are necessary. Business-related expenses may require logs or mileage records, particularly for vehicle use or travel costs. Medical deductions should be supported with bills and proof of payment.

Taxpayers claiming dependents may need to submit birth certificates, school records, or medical documents to confirm residency and relationship. Rental property owners may need to provide lease agreements, mortgage statements, or utility bills. Those reporting investment income should include brokerage statements, dividend reports, or capital gains summaries.

For self-employment income, a well-documented ledger of earnings and expenses is essential. The IRS may request contracts, invoices, or 1099 forms to verify income. Bank deposit records can further support reported earnings. If deductions for home office use are under review, floor plans, utility bills, and workspace photos can help establish eligibility.

How to Respond and Submit Information

After receiving Letter 566, review the enclosed examination notice to understand what the IRS is questioning. The agency provides a deadline for response, typically 30 days from the letter’s date. Missing this deadline can lead to adjustments without taxpayer input, potentially increasing tax liability. If more time is needed, contacting the IRS before the deadline may allow for an extension.

Responses should be well-organized and directly address the IRS’s requests. Each document should be labeled and correspond to the specific item under review. A concise cover letter summarizing the response can help clarify the information provided. If any documentation is unavailable, a written explanation along with alternative supporting evidence—such as affidavits or secondary records—can be submitted.

Submissions can be sent by mail or fax, depending on the instructions in the letter. Mailed responses should be sent via certified mail with a return receipt. If faxing, ensure all pages are legible and keep a confirmation page. Taxpayers should retain copies of everything submitted, as the IRS may request further clarification.

Potential Adjustments to Your Return

After reviewing the documentation, the IRS may modify certain items on the tax return. Adjustments can include reducing or disallowing deductions, recalculating taxable income, or reassessing eligibility for credits. If deductions are lowered, this can increase the overall tax liability, sometimes resulting in additional taxes owed with interest. Under the Internal Revenue Code, interest begins accruing from the original due date of the return, not the date of the IRS letter.

Adjustments may also trigger penalties. The accuracy-related penalty applies if there is a substantial understatement of income tax—defined as exceeding the greater of 10% of the correct tax liability or $5,000. This penalty is typically 20% of the underpaid amount. If the IRS determines a misstatement resulted from negligence or disregard of rules, the same penalty applies. While penalties can sometimes be waived with reasonable cause, taxpayers must demonstrate they acted in good faith.

Appeals Process if You Disagree

If the IRS makes adjustments you believe are incorrect, there are ways to challenge the decision. The first step is to review the IRS’s examination report, which explains the changes. If you have additional documentation or believe the IRS misinterpreted your information, you can request a reconsideration before filing a formal appeal. This often involves contacting the examiner and providing further clarification.

If an informal resolution isn’t possible, taxpayers can file an appeal with the IRS Office of Appeals within 30 days of receiving the examination report. A written protest must detail the points of disagreement, the legal or factual basis for the dispute, and any supporting documentation. The Office of Appeals operates independently from the audit division and aims to resolve disputes without litigation. If the appeal is unsuccessful, taxpayers can take the case to the U.S. Tax Court, where they can contest the IRS’s findings without first paying the disputed amount. Other options include filing a claim for a refund in U.S. District Court or the Court of Federal Claims if the tax has already been paid.