Help clients respond to an IRS correspondence inquiry
The IRS reports that document-mismatch inquiries, commonly known as CP 2000 letters, were sent to more than 4.3 million taxpayers in the 2010 fiscal year; more than $7.2 billion in additional taxes were assessed.
The dreaded CP 2000, the IRS Notice of Underreported Income, not only poses a question (did the taxpayer forget to report this income?), but it also includes a proposed adjustment to tax by presuming the answer. It’s important that the IRS receives a response to the notice by the due date shown, which is generally within 30 days. If the IRS doesn’t receive a timely response, the agency assumes the proposed changes are correct and continues processing the notice and the proposed additional tax to an assessment. Then the IRS can begin attempts to collect it.
Properly handled on a timely basis, issues covered in a CP 2000 usually can be resolved quickly and simply.
“The CP 2000 is basically a document-matching program,” says Claudia Hill, a recognized tax practitioner and Editor-in-Chief of CCH Journal of Tax Practice & Procedure. “The IRS takes information from third parties and compares it electronically with the tax return.”
Most often, taxpayers receive a CP 2000 when they did not include on their tax return income that was reported by a bank or brokerage submitting Form 1099 interest, dividends or stock proceeds. Or, they take a deduction for interest, yet none was reported to the IRS on Form 1098.
“The CP 2000 letters are computer-generated,” Hill says. The CP 2000 is generally several pages long and includes a section that describes income “Shown on Return” and asks that it be compared with information shown in a column marked “Reported to IRS (or Proposed by IRS).” The letters are essentially asking: Did you receive the income? If you received the income, was it reported on your tax return? Where?
“The matter remains untouched by human hands or eyes until the IRS receives a response,” Hill says. “If the IRS fails to receive a timely response, the matter automatically progresses to a statutory notice of deficiency. You want to avoid that.”
Here a few tips for helping a client through the process:
1. Help your client respond as soon as the data has been assembled. The taxpayer can do so by mail or fax. “If it will take you more than 30 days to obtain the data needed to respond, have your client call the IRS and ask for additional time. It’s generally better for the taxpayer to request the extension directly instead of the tax advisor. If the taxpayer is able to get through — and it may take heroic efforts — it’s unusual for the IRS not to grant an extension if it is requested in the first 30 days.”
2. Don’t assume that the information in the CP 2000 is correct. If it’s not correct, the taxpayer will still need to respond, informing the IRS why the information is not correct. Carefully document the reasons an adjustment is not needed.
3. Try to avoid a transfer to a local IRS office. “It’s extremely rare to have a valid reason to transfer a case from a CP 2000, since they’re just asking you to match documents. And it doesn’t necessarily help the taxpayer. Requesting a transfer of the case out of the automated system to a local office could expose the taxpayer to more issues than were cited in the original letter.”
4. The most important solution is to provide a timely and detailed response. “When the IRS employee eventually gets to your response and it’s methodical and organized, it will probably progress smoothly,” Hill says. “If it’s confusing or incomplete, they’re likely to disregard the response and will instead simply send out a final report of the adjustment.”
If the taxpayer’s response provides information sufficient for the examiner to conclude that no adjustment is needed, a letter closing the case will be issued. If there is no response or the examiner finds the response unsatisfactory, a statutory notice of deficiency (or 90-day letter) is sent, putting in motion a formal assessment of additional tax. At that point, the taxpayer has no other recourse than paying the tax or petitioning the U.S. Tax Court.
A high percentage of CP 2000 notices never receive a response or the response does not get effectively associated with the account. From the moment a CP 2000 letter is sent, there are many opportunities for the process to get off track, escalating the matter. “That’s what you want to avoid,” Hill concludes.