Physician Beware – IRS to Ramp Up Warning Letters

By Arden Dale, The Wall Street Journal

This fall, more taxpayers won’t be able to say they weren’t given fair warning.

The Internal Revenue Service is ramping up efforts to mail out notices in October to a wider group of people, noting that they may not be reporting enough income on their tax returns.

The warning letter differs from one the IRS has been sending for years, which suggests specific changes to income, payments, credits, deductions or other parts of the return.

That letter, known as CP 2000, proposes an adjustment to the return and may ask the taxpayer to pay additional tax. Nearly 3.5 million such letters were sent for 2007, and will continue to be sent out.

The new letter, called a CP 2057, tells recipients they may be underreporting, and instructs them to double-check parts of the return and file an amended return Form 1040X if in error. It doesn’t, however, specify the amount of additional tax that is owed.

The push is part of the IRS’s desire to narrow the so-called tax gap, or the amount of uncollected taxes. Some tax experts view the new notices as helpful reminders, while others say they will rattle many taxpayers. "If you get one of these things, you should respond," says Robert E. McKenzie, a partner at Arnstein & Lehr, a law firm in Chicago.

The new warnings are "a major rollout by the IRS, using a totally different form than in the past," says Michael O’Keefe, a manager of tax research at H&R Block.

A CP 2057 would most likely show income omitted or an expense such as mortgage interest. It might note the discrepancy if the taxpayer reported $10 in interest income but information documents showed an interest income of $200.

It asks the taxpayer to work with employers and others to correct errors in W2s, 1099s, K1s and other documents. Finally, it says the IRS will scrutinize the following year’s return to see that similar problems don’t crop up. Roughly 31,000 of the CP 2057 letters will go out in the fall, and the IRS will expand their use depending on how effective they are in getting people to correct their own returns.

The new notice is automatically generated using an IRS system of computer-matching returns with 1099, W2, K1 and other documents — a system the IRS also uses for the notices it currently sends.

The IRS hopes that the automated nature of the notices will allow it to run the program at low cost. It is designating only a tiny portion of its staff to work on it, with the aim that taxpayers will be to able to resolve underreporting issues without having to correspond extensively with the IRS.

But some tax experts question whether the program will be effective. Robert Kerr, senior director of government relations at the National Association of Enrolled Agents, wondered how the IRS is going to field all the calls from taxpayers with concerns about the notices.

The warning letters mark a significant shift in the IRS’s strategy for recovering taxes, according to Thomas P. Ochsenschlager, vice president of taxation at the American Institute of Certified Public Accountants. By giving taxpayers lead time to correct an error without actually being penalized, it "avoids the ‘gotcha!’ situation that happens so often," particularly for small-business owners who file Schedule Cs. The IRS has identified Schedule Cs as being particularly rife with potential errors.