Legal Definitions - deficiency notice

A deficiency notice, also widely known as a Ninety-Day Letter, is a formal communication issued by the Internal Revenue Service (IRS) or a state tax authority. It informs a taxpayer that the tax agency has determined there is an underpayment of tax, meaning the taxpayer owes additional tax, interest, or penalties beyond what was originally reported on their tax return.

This notice is a critical step in the tax collection process because it provides the taxpayer with a specific period, typically 90 days from the date of the notice, to take action. During this 90-day window, the taxpayer can choose to:

• Agree to the proposed changes and pay the additional amount.
• Respond to the IRS with further documentation or arguments.
• File a petition with the U.S. Tax Court to formally dispute the IRS's findings before the IRS can legally assess and collect the additional tax.

If the taxpayer does not respond or petition the Tax Court within the 90-day period, the IRS can then formally assess the additional tax and begin collection procedures.

Examples:

• Example 1: Individual Taxpayer Audit

  Scenario: After reviewing Michael's federal income tax return for a specific year, the IRS conducts an audit and concludes that he incorrectly claimed certain home office deductions, resulting in a lower tax liability than he actually owed.

  Explanation: The letter Michael receives from the IRS detailing these disallowed deductions and stating the additional tax, plus interest, that he now owes is a deficiency notice. This notice gives him 90 days to either accept the IRS's adjustments, pay the amount, or file a petition with the U.S. Tax Court to challenge the IRS's decision before they can proceed with formal collection.

• Example 2: Small Business Underreporting Revenue

  Scenario: "Bright Ideas Marketing Inc.," a small business, undergoes an IRS examination. The examination reveals that due to an accounting error, the company inadvertently failed to report a portion of its consulting revenue from a large client during a particular tax year.

  Explanation: The IRS would issue a deficiency notice to Bright Ideas Marketing Inc., outlining the unreported revenue, the resulting increase in taxable income, and the additional corporate income tax, interest, and potential penalties due. This notice serves as the formal notification that triggers the 90-day window for the company to respond, provide further evidence, or appeal to the Tax Court.

• Example 3: Gift Tax Valuation Dispute

  Scenario: A wealthy individual makes a significant gift of privately held stock and files a gift tax return, valuing the stock at a certain amount. The IRS later reviews the return and disputes the valuation of the gifted stock, asserting that its fair market value was considerably higher than reported, thus increasing the total gift tax liability.

  Explanation: The communication from the IRS informing the individual of this revised valuation and the resulting additional gift tax due is a deficiency notice. It provides the individual with the opportunity to challenge the IRS's valuation in Tax Court within the specified 90-day period before the higher tax amount is formally assessed and becomes due.