What Is a Notice of Deficiency?
A Notice of Deficiency, often referred to as a "90-day letter," is a formal communication from the Internal Revenue Service (IRS) to a taxpayer, stating that the IRS has determined an additional amount of tax is owed (a "deficiency") for a specific tax period. This critical document falls under Tax Law and financial regulation, serving as a prerequisite for the IRS to legally assess the proposed tax, interest, and any associated Penalty or Interest if the taxpayer does not agree or respond. The Notice of Deficiency provides the taxpayer with the legal right to challenge the IRS's findings in the United States Tax Court without first paying the disputed amount.30,29
History and Origin
The concept of a Notice of Deficiency is rooted in the legislative framework designed to balance the government's need to collect taxes with the Taxpayer Rights to due process. Prior to the establishment of the U.S. Tax Court and the formal notice procedures, taxpayers often had to pay disputed tax amounts first and then sue for a refund, which placed a significant burden on individuals and businesses. The Revenue Act of 1924 established the Board of Tax Appeals (the precursor to the U.S. Tax Court) and mandated that the Commissioner of Internal Revenue issue a "notice of deficiency" before assessing additional income, estate, or gift taxes. This allowed taxpayers to dispute the proposed tax in an independent forum before payment. Current law, specifically 26 U.S. Code § 6212, authorizes the Secretary of the Treasury to send such notices by certified or registered mail if a deficiency is determined.,28
27
Key Takeaways
- A Notice of Deficiency is a formal IRS letter proposing additional tax, interest, and penalties.
26* It is a prerequisite for the IRS to assess certain taxes and grants the taxpayer the right to petition the U.S. Tax Court.,25
24* Taxpayers generally have 90 days (150 days if outside the U.S.) from the mailing date of the Notice of Deficiency to file a petition with the U.S. Tax Court.,23
22* Failure to respond or petition the Tax Court within the deadline means the proposed deficiency becomes legally assessed and collectible.
21
Interpreting the Notice of Deficiency
Upon receiving a Notice of Deficiency, prompt action is critical. The document will outline the proposed changes to the taxpayer's Tax Liability, the reasons for these changes, and the recalculated tax amount. It typically arises after a Tax Audit or an examination where the IRS has identified discrepancies in reported income, Deductions, or Credits.
20
The notice usually specifies a deadline, most commonly 90 days from its mailing date, within which the taxpayer must respond. This period is jurisdictional, meaning the United States Tax Court cannot extend it.,19 18Taxpayers have generally two main options: agree with the proposed deficiency and pay the amount, or dispute it. If disputing, they can attempt to resolve it through the IRS Appeals Process or by filing a petition with the U.S. Tax Court.
17
Hypothetical Example
Consider Sarah, a self-employed graphic designer. In January, she receives a Notice of Deficiency from the IRS concerning her tax return from three years prior. The notice states that based on information received from third-party payment processors, her reported Gross Income was understated, leading to a proposed additional tax liability of $5,000, plus interest and penalties. The notice is dated January 15, and it explicitly states that Sarah has 90 days to respond or petition the U.S. Tax Court.
Sarah reviews her records and realizes she accidentally omitted some freelance income when preparing her return. If she agrees with the IRS's findings, she can sign the enclosed waiver form and pay the amount due. However, if she believes the IRS's calculation is incorrect, perhaps because she overlooked a legitimate Deduction, she must either contact the IRS for an administrative review or, more formally, file a petition with the U.S. Tax Court by April 14 (90 days from January 15). If she does nothing, after April 14, the IRS will formally assess the $5,000 plus interest and penalties, making it a legally collectible debt.
Practical Applications
Notices of Deficiency are primarily used by the Internal Revenue Service (IRS) when it determines a taxpayer owes additional income, estate, gift, or certain excise taxes. They serve as a critical step before the IRS can make a formal Tax Assessment of the disputed amount. The notice is a taxpayer's "ticket" to the U.S. Tax Court, allowing them to litigate the dispute without having to pay the tax first.,16
15
These notices are commonly issued after a Tax Audit where an agreement could not be reached, or when the IRS identifies unreported income through information matching programs. They are also sent if the taxpayer fails to respond to earlier IRS correspondence proposing adjustments. The formal process ensures adherence to legal protocols before the government can enforce collection. The IRS provides guidance on what to do when receiving such a notice, emphasizing the importance of understanding the proposed changes and available response options.
14
Limitations and Criticisms
While designed to protect taxpayer rights, the Notice of Deficiency process has limitations. One significant constraint is the strict 90-day (or 150-day for those outside the U.S.) deadline for filing a petition with the U.S. Tax Court. This deadline is jurisdictional, meaning that missing it, even by one day, can lead to the loss of the right to challenge the deficiency in Tax Court without prepayment.,13
12
Taxpayers may find the notice complex, potentially leading to confusion regarding their options or the underlying tax law. The reliance on the "last known address" for mailing the notice can also create issues if the IRS does not have an updated address, potentially leading to a taxpayer not receiving the notice in time to respond. 11Furthermore, while the notice generally applies to income, estate, and gift taxes, certain Penalty assessments, particularly some international information reporting penalties, may not require a Notice of Deficiency, limiting a taxpayer's prepayment appeal rights.
10
Understanding the Statute of Limitations for assessments is crucial, as the IRS must generally mail the Notice of Deficiency within this period. Disagreements can sometimes arise concerning the accuracy of the Administrative Record the IRS relied upon, or whether the IRS followed proper procedures.
Notice of Deficiency vs. Tax Lien
A Notice of Deficiency is a pre-assessment notification from the IRS, informing a taxpayer that the agency believes additional tax is owed and providing an opportunity to dispute it in U.S. Tax Court before the tax is formally assessed and collected. It is a proposed determination of tax liability.
Conversely, a Tax Lien is a legal claim the IRS places on a taxpayer's property (real or personal) once a tax assessment has been made, and the taxpayer has failed to pay the tax after notice and demand. A tax lien is an enforcement action, securing the government's interest in the taxpayer's assets to satisfy an existing, unpaid tax debt. It typically arises after a Notice of Deficiency has been issued, the 90-day period has expired without a Tax Court petition, and the IRS has formally assessed the tax.
FAQs
What should I do if I receive a Notice of Deficiency?
You should carefully review the notice, understand the proposed changes, and determine if you agree or disagree. If you disagree, consider contacting the IRS or a tax professional to discuss your options, which include seeking an administrative appeal or filing a petition with the United States Tax Court within the specified deadline.
9
How much time do I have to respond to a Notice of Deficiency?
Generally, you have 90 days from the date the notice is mailed to file a petition with the U.S. Tax Court. If the notice is addressed to a person outside the United States, this period is extended to 150 days. It is critical to adhere to this deadline, as extensions are typically not granted.,8
7
What happens if I ignore a Notice of Deficiency?
If you do not respond to the notice or file a petition with the U.S. Tax Court within the allotted time, the IRS will proceed with formally assessing the proposed Tax Liability, along with any applicable Penalty and Interest. Once assessed, the IRS can begin collection actions, which may include levies or filing a Tax Lien against your property.,6
5
Can I still negotiate with the IRS after receiving a Notice of Deficiency?
Yes, even after receiving a Notice of Deficiency, you may still be able to resolve your case with the IRS, often through the IRS Office of Appeals Process. Filing a petition with the Tax Court often leads to the case being sent to Appeals for settlement efforts before a trial.,4
3
Does a Notice of Deficiency apply to all types of taxes?
No, the requirement for a Notice of Deficiency primarily applies to federal income, estate, gift, and certain excise taxes. It typically does not apply to payroll taxes or certain penalties that can be assessed immediately.,21