Decoding IRS Letter 566: A Taxpayer's Guide to Correspondence Audits

Receiving a letter from the Internal Revenue Service (IRS) can be an intimidating experience for any taxpayer. Among the various notices the IRS sends, Letter 566 is particularly significant as it signals the initiation of a tax audit. However, understanding what this letter entails and how to properly respond can demystify the process and alleviate much of the associated stress. This article provides a comprehensive overview of IRS Letter 566 to offer  detailed guidance for taxpayers. 

What is IRS Letter 566? 

IRS Letter 566 is an initial contact letter that informs a taxpayer that their tax return has been selected for an audit, also known as an examination. Specifically, this letter is used for a correspondence audit, which means the examination is conducted entirely by mail. This is the most common type of audit, and in Fiscal Year 2017, the IRS conducted approximately 71 percent of all individual audits by correspondence. 

The letter will identify the specific tax year under review and pinpoint the exact items on the tax return that the IRS is questioning. It will also include a request for the taxpayer to provide documentation to substantiate these items. There are several variations of Letter 566, each tailored to specific circumstances. For instance, Letter 566-S is generally used for the audit of a particular item, while Letter 566-E is typically used for examining wages, withholding, and refundable credits. 

Why Was Your Return Selected for Examination? 

The selection of a tax return for an audit does not necessarily imply that the taxpayer has made an error or been dishonest. The IRS uses a variety of methods to select returns for examination. The primary selection criteria include: 

Computer Scoring: The IRS uses a computer program called the Discriminant Inventory Function System (DIF) to score tax returns based on the potential for errors. A higher DIF score increases the likelihood of an audit. 

Third-Party Information Matching: Information from third-party sources, such as Forms W-2 from employers and Forms 1099 from banks or other payers, is matched against the information reported on the tax return. Discrepancies can trigger an examination. 

Related Examinations: A taxpayer's return may be selected for audit if it involves transactions with other taxpayers, such as business partners or investors, whose returns have been selected for examination. 

Information from Other Sources: The IRS may receive information from various sources, including public records and informants, that suggests potential non-compliance with tax laws. 

Navigating Your Response to Letter 566 

Upon receiving Letter 566, it is crucial to respond in a timely and organized manner. The letter will typically provide a 30-day deadline for the taxpayer to reply. Ignoring the notice can lead to serious consequences, including the disallowance of the questioned items and the assessment of additional tax, penalties, and interest. 

Here are the steps to take when responding: 

1. Read the Letter Carefully: Understand which tax year is being audited and which specific items are under scrutiny. The letter will list the documents you need to provide. 

2. Gather and Organize Your Documents: Collect all relevant records, such as receipts, bank statements, and legal documents, that support the items being questioned. It is essential to send copies of your documents, not the originals. Be sure to include your name and Social Security Number on each page. 

3.Prepare Your Response: Write a clear and concise cover letter to accompany your documents. Reference the letter number (e.g., Letter 566-S) in your correspondence. 

4.Respond by the Deadline: Mail or fax your response to the address or number provided in the letter. If you need more time, you can call the examiner to request an extension. 

Your Rights as a Taxpayer 

During an examination, taxpayers are protected by a set of rights known as the Taxpayer Bill of Rights. These rights include: 

• The Right to be Informed 

• The Right to Quality Service 

• The Right to Pay No More than the Correct Amount of Tax 

• The Right to Challenge the IRS’ Position and be Heard 

• The Right to a Fair and Just Tax System 

Furthermore, Internal Revenue Code (IRC) § 7605 and Treasury Regulation § 301.7605-1 provide specific protections regarding the time and place of examinations. These provisions ensure that the examination is conducted at a reasonable time and place, and they protect taxpayers from unnecessary examinations and investigations. For example, the IRS is generally restricted to one inspection of a taxpayer's books of account for each taxable year unless the taxpayer requests otherwise or the IRS provides written notice that an additional inspection is necessary. 

The Legal Framework Behind Correspondence Audits 

The authority for the IRS to conduct examinations is rooted in IRC § 7602. While correspondence audits are intended to be an efficient way to resolve simple tax discrepancies, the Taxpayer Advocate Service has noted that they can sometimes place a significant burden on taxpayers, especially when the issues are more complex than they initially appear or when there are difficulties in communication. 

Conclusion 

Receiving IRS Letter 566 can be a source of anxiety, but it is a manageable situation. By understanding the nature of a correspondence audit, the reasons for your return's selection, and the proper way to respond, you can navigate the process effectively. Remember to be organized, responsive, and aware of your rights as a taxpayer. If you feel overwhelmed, do not hesitate to seek professional tax assistance. 

To learn more about how to fix your IRS issues, click the button to watch the free video, The Ultimate Guide to Solving Your IRS Tax Problems: 

Click Here