If you have received a letter via regular mail from the Internal Revenue Service (IRS) asking about a tax position you took on a recent return or requesting additional information, it was likely a soft letter. These letters are one of several pre-audit tools that the agency uses to encourage taxpayers to voluntarily comply with a request.
Soft letters are intended for cases that could potentially be resolved without further IRS contact or examination. At its gentlest, the letter might note that the IRS has observed certain treatment, remind the taxpayer of relevant law, and ask the individual to consider whether appropriate action was taken.
A stronger soft letter could serve as a warning of future scrutiny. Such a letter might suggest a risk of non-compliance and urge the taxpayer to respond in order to avoid further IRS interaction. If the taxpayer doesn’t respond or they do but the explanation is inadequate, the IRS might then initiate an examination.
IRS Using Soft Letters More Often
The IRS has used this tool more frequently in the last few years. The IRS Tax Exempt and Government Entities group specifically noted in its fiscal-year 2019 annual newsletter that it had expanded use of the soft letter as a compliance tool. The group noted soft letters are also a way to improve the taxpayer experience along with filing accuracy. This group deals with non-profits, employee plans and tax-exempt bonds.
Here are some recent examples of areas where the IRS has used a soft letter as a first step in compliance:
- Tax benefit from captive insurance arrangement – in March 2020, the IRS mailed thousands of soft letters to taxpayers who had reported involvement in captive insurance arrangements. The March letters noted that the IRS is beefing up examinations in this area and warned of disallowance of claimed micro-captive insurance deductions. The letters asked taxpayers who were no longer participating in these arrangements to notify the IRS. For those still involved in these arrangements, the IRS advised consulting a tax professional. A second wave of letters went out in July 2020.
- Underreporting virtual currency revenue – in the summer of 2019, the IRS sent letters to more than 10,000 of taxpayers asking about failure to report income and pay the resulting taxes on virtual currency transactions. There were three versions of the letter, all of which reminded taxpayers of their filing and tax obligations along with actions to correct errors. The year before issuing the soft letters, the IRS had announced a virtual currency compliance campaign and noted the currency as an ongoing area for criminal investigation.
- Foreign corporations failing to report US income – the IRS has used soft letters as the first step to encourage foreign corporations to report US income and then proceeded to examination when appropriate.
- Unreported foreign income by individuals – taxpayers who the IRS believed did not report foreign income received soft letters in 2018. These taxpayers were offered three options: participating in compliance procedures, submitting a specific form accompanied by extensive supporting documents, or submitting a narrative as to why the taxpayer was fully compliant. Taxpayers who did not respond were warned of being selected for a tax audit.
Have Questions? Call the Experienced Tax Attorneys at Wiggam & Geer
If you have received a soft letter, particularly one requesting action, and have questions or want advice on how to respond, we can help. The experienced attorneys at Wiggam & Geer can evaluate the situation, recommend a course of action, and represent you at any point the issue becomes an IRS claim or investigation. Contact metro Atlanta’s top tax and bankruptcy attorneys by clicking here or giving us a call at (404) 609-1300.