Underreported income continues to be a focus for the IRS, with some studies suggesting that the average American underreports their income by 4-5%. Although randomized audits and field investigations are still common, the IRS also uses sophisticated technology to tackle the problem. The Automated Underreporter (IRS AUR) is a program that’s designed to identify underreported income by checking for inconsistencies in tax returns.
Automated Underreporter: A Comprehensive Guide
The Automated Underreporter is used by the IRS Underreporting Department, which operates by combining automated checks with manual assessments from IRS auditors. The goal is to identify underreported income, so taxpayers can be contacted and underpaid taxes settled.
How Does It Work?
Every tax filing can be checked by the AUR system, but not all will be selected. The IRS uses a range of different methods to decide which returns will be subject to further checks. Any obvious errors or inconsistencies can flag a return for an AUR check, but the IRS also uses a statistical model of probability to select higher risk returns. Some tax returns will also be chosen for an AUR check as part of a randomized sample.
The automated underreporter cross-checks all the data it holds in the system and searches for discrepancies. The IRS expects all types of reportable income to be included on a tax return, not just earned income from business or employment. Some of the data the IRS AUR system could check includes:
- Employer returns, including wages and taxes
- Fees paid to contractors, including royalties
- Interest
- Dividends
- Real estate returns
- Retirement account income
- Forgiveness of debt
- Sale of securities
- Third-party payment reports, such as PayPal
- Cryptocurrency sales
Discovery of Unreported Income
If the automated underreporter program finds a discrepancy, a CP2000 notice will be generated. The results of the automated report are typically not manually checked, as the IRS assumes that the system is correct. If the CP2000 notice contains an AUR control number printed in the right-hand corner, this means that no manual checks have taken place.
The CP2000 is not a bill: it is a notice of proposed changes to the tax record. The notice contains information about the discrepancy between the reported income and the information held by the IRS. It is not illegal to ignore the CP2000 as the IRS can proceed without a response. However, it’s better to respond to this notice, even if the proposed changes seem to be correct.
What To Do If You Receive a CP2000 Notice
Receiving a CP2000 can be a shock, but the outcome is not simply a formality. If the information is incorrect, it’s possible to get the proposed changes overturned and any penalties struck off, especially if you use an experienced tax attorney. If you receive a CP2000 notice, follow the steps below:
- Read the notice carefully to understand the discrepancy
- Cross-check the CP2000 with your own records
- Gather any documentation to prove your case
- Contact a tax professional for help formulating a response
- Agree the AUR response with the tax professional
- Check historical tax returns for similar errors and omissions
- Pay any additional taxes owing to the IRS
Responding to the CP2000
If no response is submitted, the IRS will proceed to issue a Statutory Notice of Deficiency and a bill. However, it’s not advisable to simply ignore the notice, even if the changes seem to be correct. By sending a response, it’s possible to request that any penalties are waived.
If the CP2000 is not correct, it can be challenged either partially or wholly. The burden of proof is on the individual to prove that the CP2000 is incorrect, so any challenge should include documentary evidence. The IRS can typically take up to 180 days to consider a CP2000 response and will either agree to some or all of the changes or stick to their original CP2000 notice. If the individual and IRS cannot reach an agreement, the case can be referred to the courts.
Penalties for Underreported Income
If the CP2000 is correct and income has been underreported, the balance of taxes must be paid. However, the IRS may also impose penalties depending on the reason for the underreporting and the scale. These can be split into two categories:
Negligence or Disregard
For the purposes of penalties, negligence and disregard are grouped together. Disregard is considered to have occurred when tax rules have been “carelessly, recklessly, or intentionally ignored.” Negligence is assumed if “reasonable efforts” are not made to follow tax regulations and laws.
The standard penalty for negligence or disregard is 20% of the total amount of tax that was underpaid due to the disregard or negligence. Interest will accrue on the penalties due and will continue until all taxes and penalties have been paid in full.
Substantial Understatement
A substantial understatement penalty will apply if the tax is underpaid by 10% or more or the amount owing exceeds $5000. This amount reduces to 5% or $5000 if a Section 199A Qualified Business Income Deduction is claimed on the tax return.
The penalty for a substantial understatement is 20% of the total amount of tax that has been underpaid. Interest will apply and continue to accrue until the balance is settled in full.
Can Penalties Be Waived?
In some cases, the IRS may be willing to waive part or all of the penalties for underreported income. This will not be done automatically and must be requested. A penalty will only be reduced if an individual is able to prove that they acted in good faith and can demonstrate a reasonable cause for the failure to meet their tax obligations.
Interest on penalties will be recalculated if the IRS agrees to a reduction or removal of a penalty. By law, interest on penalties cannot be recalculated unless the penalty is reduced.
Flaws Within the Underreporter Program
Although the IRS AUR is a powerful tool, it’s not infallible. The automated checks that take place are typically not subject to manual verification, which means there’s a reliance on the data being correct. There is an assumption that data held within the IRS reporting system is correct and the taxpayer is wrong. This means that the taxpayer must be able to identify and demonstrate any errors, as the IRS won’t do their own checks.
The data held by the IRS will often be accurate, which means that the checks carried out by the Underreporting program will be correct. However, if third parties have made mistakes in submitting their returns, this can lead to false results. There may also be other legal exemptions that aren’t held within the AUR system. All of this means that the Underreporter system may sometimes produce incorrect conclusions which the taxpayer will have to challenge.
Here at Silver Tax Group we have many years of experience in dealing with all kinds of tax queries, including IRS AUR notices. Our dedicated tax attorneys know what it takes to put together a successful CP2000 challenge and can help to correct any tax problems. Get in touch with our team here at Silver Tax Group in Farmington Hills, MI for a free initial consultation.
