Deficiency

A deficiency is the numerical difference between the amount of tax that a taxpayer, or taxpaying entity, reports on a tax return and the amount that the Internal Revenue Service (IRS) determines is actually owed. The term only applies to shortfalls and not to surpluses. Taxpayers are notified of deficiencies via deficiency letters.

A deficiency is located during internal audits levied by the IRS that compare the various forms that have been submitted. Entities that report taxpayer liabilities include banks, employers and other businesses.

A deficiency is assessed when the amount or tax liability reported to the IRS by the taxpayer is less than the amount reported by third parties. Third party documents are an indication to the IRS that a form of income was received by the taxpayer.

Deficiencies can easily become back taxes if prompt action is not taken by taxpayers. A notice of deficiency does not automatically equate to an audit or disciplinary action, but it should be taken seriously. Taxpayers can use the contact information provided on the deficiency letter to contact the IRS for further information.

A deficiency results when a W-2 submitted by an employer is not reported as income by the taxpayer. As the IRS reviews the documentation provided by employers, items are compared to those reported by the taxpayer. If the IRS locates a W-2 supplied by an employer, but not reported by the employee, a deficiency is assessed.

Deficiencies are also assessed due to inconsistent data. This includes when reported income on the W-2 and that reported on tax documents, such as a 1040, don’t match. Whether intentional or accidental, any additional liability is assessed as a deficiency. An official audit can also produce a deficiency. During an audit, the IRS will analyze all of the information and documentation as part of the particular tax year’s return. If it is determined that additional taxes are owed, a deficiency results.

A form CP3219A, Notice of Deficiency, is sent after a first notice and Examination Report are sent and ignored. The notice, which is not a tax bill, specifies the inconsistencies between the taxpayer's reported tax liability and the liability assessed by the IRS. Once the document is received, the taxpayer must respond within 90 days on Form 5564, Notice of Deficiency – Waiver, if the taxpayer agrees that the deficiency indicated by the IRS is accurate. Should the taxpayer disagree with the assessment, they can choose to contest the deficiency. This requires contact with the IRS to officially begin the process.

There are several consequences if you ignore the Notice of Deficiency and do not to pay your tax liability. The IRS can enforce and impose tax liens on your wages or bank account, tax levies by seizing your property or other assets, or even launch a criminal investigation which could lead to jail time. 

If the deficiency is a result of fraud or identity theft, the taxpayer must report this information with the IRS. Fraud may result if an incorrect amount is intentionally listed by the employer on the taxpayer’s W-2. Identity Theft may result if a person other than the taxpayer works while falsely claiming the taxpayer’s name and social security number as their own. A taxpayer will not be made liable for income tax on income they did not themselves earn.