How an IRS Notice Could Indicate Fraud

According to the IRS, the agency sends out millions of notices and letters to taxpayers and businesses. While the prospect of responding to a letter from the IRS seems daunting, the process may not be as overwhelming as you might think.

In some cases, the IRS is just requesting additional information to complete their review process. In other cases, the IRS has identified a discrepancy between two different reports and needs your help in reconciling the difference.

While the process may not be complicated, it may involve a lot of time to research and document your side of the story. However, it’s very important to respond to these notices.  Ignoring the request for information will only complicate the matter and may have unintended consequences.  

Revealing Potential Problems
A notice from the IRS may reveal potential problems that need to be corrected. Even if you don’t think the error is on your part, you should perform due diligence to research the discrepancy and respond appropriately. 

Example: One church received multiple notices from the IRS that they had underpaid their payroll tax.  The bookkeeper, who believed the discrepancy was in error, ignored the notices.  After sending notices for a couple years, the IRS put a lien on the church and levied taxes and penalties in excess of $40,000.  At this point, the church determined it was time to respond and concluded the bookkeeper had been overstating wages on IRS Form 941, Employer’s Quarterly Federal Tax Return for a number of years. The IRS saw the inflated wages and expected the church to remit additional payroll taxes. When the remitted taxes were less than expected, the IRS sent notices about the discrepancy, which were ignored. In order to reverse the IRS’s lien, the church had to pull together several years of payroll documentation and send corrected forms to the IRS.  While the IRS reviewed their case, the penalties and fees continued to accrue.

A notice from the IRS may reveal fraud or abuse that is occurring in the church—often times in the payroll function. If an employee is stealing funds, they will often cover their tracks by falsifying reports, moving money between funds, and borrowing from designated funds, like funds designated for payroll taxes. If payroll taxes are not remitted properly, it won’t take long for IRS to notice. 

Tip: To reduce the risk of fraud, and ensure proper accountability and transparency, any notices from the IRS should be sent to at least two people.  One copy can be given to the bookkeeper for action, and one copy should be sent to the pastor or board so that they can ensure the notice is appropriate and handled in a timely manner.

A notice may also reveal abuse that is occurring from outside the entity, which 1,000 small businesses and nonprofits in the New York area recently experienced:

Example: A third party payroll provider in New York was hired to process payroll checks, remit taxes and file appropriate payroll reports with the IRS.  However, while the fraudulent payroll provider collected over $3 million in payroll taxes from his clients, he failed to remit the taxes to the IRS. Instead, the president of the company used the funds for operating expenses and personal expenditures. While he was sentenced to eight years in prison, his clients are still liable for the unpaid taxes.  For many clients, the IRS notices were the first indication that something was amiss.

Action Steps
If you receive a notice from the IRS, the agency offers the following five steps to properly deal with it¹: 

• Don’t Ignore It. You can respond to most IRS notices quickly and easily. It is important that you reply right away. 
 
• Focus on the Issue. IRS notices usually deal with a specific issue about your tax return or tax account. Understanding the reason for your
notice is important before you can comply.  (See additional resources below for help.)

• Follow Instructions. Read the notice carefully. It will tell you if you need to take any action to resolve the matter. You should follow the
instructions. 

• No Need to Visit IRS. You can handle most notices without calling or visiting the IRS. If you do have questions, call the phone number in the
upper right corner of the notice. You should have a copy of your tax return and the notice with you when you call.
 
• Keep the Notice. Keep a copy of the notice you get from the IRS with your tax records.

Other Tips
The IRS may send a Correction Notice. If the letter says that the IRS corrected your tax return, you should review the information provided and compare it to your tax return.

• If you agree, you don’t need to reply unless a payment is due.

• If you don’t agree, it’s important that you respond to the IRS. Write a letter that explains why you don’t agree. Make sure to include information and any documents you want the IRS to consider. Include the bottom tear-off portion of the notice with your letter, and mail your reply to the IRS at the address shown in the lower left part of the notice. You should expect to wait at least 30 days for a response from the IRS.

For individual taxpayers, the IRS may send a notice related to the Premium Tax Credit. The IRS may send you a letter asking you to clarify or verify your premium tax credit information. The letter may ask for a copy of your Form 1095-A, Health Insurance Marketplace Statement. You should follow the instructions on the letter that you receive to help the IRS verify your information and issue the appropriate refund. 

Lastly, Watch Out for Scams. Don’t fall for phone and phishing email scams that use the IRS as a lure. The IRS first contacts people about unpaid taxes by mail – not by phone. The IRS does not initiate contact with taxpayers by email, text or social media.
 
Additional IRS Resources:
• Tax Topic 651, Notices – What to Do
• Tax Topic 653, IRS Notices and Bills, Penalties and Interest Charges
• Understanding Your IRS Notice or Letter
•IRS warning: Scammers work year-round; stay vigilant

¹Adapted from IRS Summertime Tax Tip 2015-05