While receiving an IRS notice of deficiency in the mail will make anyone’s knees quiver, most tax discrepancies result from honest errors and can be resolved in short order. Here’s what to know.
When the IRS establishes that your tax account owes money – perhaps due to a missed tax payment, an incorrect calculation on your part, or an error on your return – it will inform you of the discrepancy on your tax account through the mail. One of the first things the IRS will do is send you a 30-day letter. It is called a 30-day letter because you have a whole month to respond to the IRS before it will process the discrepancy and put it froth on your account. This means you have a month to challenge the IRS’ findings – failing will officially put you in tax debt. At this point, the IRS will send you a notice of deficiency (NOD). But, this is the IRS informing you that you owe them income tax money, and you should pay them as soon as possible.
Understanding Your Notice of Deficiency
A 30-day letter should alert you to the problem the IRS has discovered. A notice of deficiency should go on to inspire even further agency. One way or another, the IRS will do its best to get its hands on the money owed – and in the meantime, it will begin to levy penalties on your tax account for every month that your debt goes unpaid. From the day you were issued your notice of deficiency, you have 90 days to respond with evidence disputing the IRS’ decision or take them to tax court over the matter.
If you do not believe that you owe additional taxes or are underpaid and have the evidence to prove it, take this opportunity to call a tax professional and schedule a consultation. You may have a chance at appealing the IRS’ decision – but only a trained attorney or tax professional can make the call on that based on your circumstances. If you cannot dispute the IRS’ claims and do owe a tax debt, then contacting the IRS to resolve the matter as soon as possible is within your best interests. Otherwise, things can change quickly and go from bad to worse. If you agree with the IRS’ estimation, the notice will instruct you to sign a Waiver Form 4089.
What Will the IRS Do Next?
The notice of deficiency itself is not a tax bill. It does precede your tax bill, however, and after either the entire 90-day period has elapsed, or after the IRS has received your waiver form in writing, they will be able to charge you for the tax due. Your failure to respond to the IRS at this point will result in collection actions. Don’t worry – the IRS will continue to take its time here unless your tax debt is substantial or you are a flight risk. Tax debt doesn’t disappear overnight, unfortunately.
It is difficult to get rid of, and even if you are in a financially dire situation, bankruptcy might not be the best way out. Tax debts do expire, but it takes ten years (plus any applicable tolling periods or extensions) – and the IRS, as a powerful creditor backed by the government, has several ways to claim your wealth involuntarily. Then there’s also the fact that intentionally avoiding your tax debt can give the IRS grounds to charge you with a crime. All in all, one way or another, you must deal with your tax debt and ideally do so quickly.
Notice of Federal Tax Lien and Levies
Let’s say you received your notice of deficiency about a month ago. You know you owe the IRS money, and the IRS knows it too. It hasn’t heard back from you. Can you expect a SWAT team to knock down your doors and arrest you? No, not quite. If you do not intend to let the IRS know that you agree with their assessment, they can continue to penalize your tax account and add to your debt at a steep rate.
Interest rates are also applied to underpayment and overpayment of tax (i.e., tax refunds), so time is of the essence here. Once the IRS establishes that you do not intend to pay your tax debt back as soon as possible, it can begin to apply pressure on your tax account via a public notice of a federal tax lien. Tax liens are a creditor’s legal insurance of their claim on your wealth over that of other creditors.
When a creditor applies a lien, they effectively tell further potential and current creditors that their debt supersedes the others and must be paid off first. Furthermore, a lien keeps you from selling or liquidating any of your assets without first satisfying your debt with the government. It is a financial ball and chain. It is also a public ball and chain. All creditors can see whether a person is under a federal tax lien, which massively undermines their ability to seek credit or get financing.
It also makes it harder for you to secure a debt, as the IRS technically claims everything you own. In the past, tax liens imposed an even harsher punishment on taxpayers in the form of a black mark on your credit score, roughly on the same level as a bankruptcy. This mark would last about seven years, affecting your ability to seek financing, lease cars or property, or get a mortgage even after you’ve paid off your debt.
Thankfully, all major credit reporting agencies have stopped lowering credit scores in response to a federal tax lien. But that does not make them any less public. Levies are something else. When people talk about the IRS claiming houses and cleaning out your bank accounts, they talk about a levy. However, it isn’t something the IRS does lightly. Levies are the IRS’ last resort to satisfying your debt and only an option when all attempts at establishing a payment plan have been exhausted.
There’s no other way to secure your tax liability. The IRS can theoretically even claim your home but will usually avoid it. Instead, the IRS cleans out bank accounts, investment properties, and rental properties, and if you own nothing else, you can begin claiming a portion of your monthly wages through your employer.
What If You Can’t Pay?
The IRS is not entirely inflexible. If your financial situation is dire enough, you can negotiate a more feasible payment plan over the long term, usually about six years. If you cannot pay off your entire debt over 72 months and can prove that you do not have the financial means, the IRS may lower your debt through an offer in compromise (OIC) settlement. However, you must make that offer yourself, and the IRS can reject it. It is in your best interests to deliver a realistic offer that matches the IRS’ expectations based on your financial information, as provided through a Collection Information Statement.
When even an offer in compromise isn’t on the table, you can seek low-income taxpayer help to declare yourself temporarily not collectible. This forces the IRS to cancel collection actions until your financial situation improves (your debt will still incur applicable penalties and interest, however). Liens and levies are powerful collection tools. But you can stop them. Talk to a tax professional about establishing a payment plan or negotiating with the IRS.