Soft Letter vs. Penalty Notice vs. IRS Audit
Soft Letter vs. Penalty Notice vs. IRS Audit: When a taxpayer receives a notice from the IRS, it can be an unsettling and daunting experience. When it comes to offshore fines and penalties, the letter will generally fall into one of three categories:
- Soft Letter
- Penalty Notice
- IRS Audit Notice
The seriousness of the letter and necessary response time (if any) is determined by the type of letter – and not all IRS letters are built the same. While receiving any IRS letter is no fun, some situations are worse than others.
Let’s review the difference between a Soft Letter, Penalty Notice, and IRS Audit.
IRS Soft Letter
When a person receives a soft letter from the Internal Revenue Service, it is essentially a reminder to let them know that something about their prior tax year reporting was incorrect or incomplete. Soft letters are common for matters involving foreign asset reporting on Form 8938 and cryptocurrency (in which IRS letters 6173 and 6174 are used).
An all-too-common situation occurs when a US person has a foreign bank account at a foreign financial institution in a country that has entered into a FATCA Agreement with the US. In accordance with the IGA (Intergovernmental Agreement), the foreign financial institution is tasked with reporting US account holders to the IRS.
If a foreign financial institution reports a US taxpayer to the US government, but that taxpayer has not properly reported the existence of the account on the requisite IRS international information return submission form — it may lead to the IRS sending a soft letter to the taxpayer.
Taxpayers may not need to contact the IRS in response to the soft letter, but will have to take some action — such as going back and fixing amended or original tax returns/information returns — but not always.
A penalty notice is different than a soft letter — and is generally much more serious. That is because with a penalty notice, the Internal Revenue Service not only has information that something is inaccurate about the taxpayer’s return, but the IRS has already issued a penalty.
This is common in situations in which a taxpayer may not have filed a timely Form 3520 or Form 5471 — and the IRS gets wind of the foreign gift, trust, or foreign corporation reporting noncompliance before the taxpayer has an opportunity to solve the problem.
One very common penalty notice that US persons will receive if they have an international reporting noncompliance issue is a CP15 notice.
There are very strict reporting timelines and requirements involving the response to a Form CP-15 notice — so if a taxpayer receives one of these types of notices, it is important to formulate a strategy and respond timely (if responding is the strategy).
IRS Tax Audit Notice
When a taxpayer receives an audit notice from the IRS, it means the IRS wants to conduct an examination on one or several issues involving the taxpayer’s tax return or reporting form. Some audits are narrowly tailored, while other audits can be much more encompassing.
In addition, some audits may start out narrowly tailored, but as the audit progresses and the IRS discovers either additional unreported income — or possibly undisclosed foreign accounts, assets, or investments — the audit expands.
Not All IRS Communications Are the Same
When a person receives an IRS notice, it can be a scary and overwhelming experience — but that does not mean that the taxpayer is necessarily going to be under audit or penalized. There are various different types of notices and letters a taxpayer may receive from the IRS — as well as different levels of noncompliance. Common examples of IRS Notices include a soft letter, penalty notice, or an audit notice. It is important to understand which type of correspondence the taxpayer has received before the taxpayer reaches out and communicates with the IRS.
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Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
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