- Under reported income includes any earnings subject to tax that are left off of a tax return
- The largest portion of the tax gap tracked by the IRS is made up of underreported income
- Taxpayers may underreport income due to a desire to avoid paying tax or simple mistakes
- What to do if you receive a CP2000 notice:
Read the notice carefully
Respond right away
Submit documentation if you disagree
Look for mistakes on other returns
- Contact a Tax Attorney
Many taxpayers don’t report their entire income on their tax returns, even though they may file on time. This is called underreporting, and it’s the cause of most of the tax gap the IRS tracks. Tax gap is the difference between the actual tax liability for a period and the amount of tax that is paid on time.
The IRS found that between 2014 and 2016, around 85% of taxes were paid voluntarily and on time, and data projections for 2017-2019 estimate that 85.1% were paid voluntarily. The IRS also found in its projections for 2017-2019 that $433 billion of the $540 billion tax gap was from underreported income.
Underreporting is common for many Americans, as is clear from those numbers above. You are not alone if you have accidentally underreported your income, as sometimes the issue is just a simple mistake.
This guide will help you navigate the situation regardless of the reason for underreporting, and covers how to respond appropriately to avoid the underreported income IRS penalty.
How the IRS Defines Underreporting Income
Taxpayers may underreport their income accidentally or on purpose. They may complete their tax return as normal and on time, but report less income than what they actually made for the year. They have unreported income in all of these situations, which is a problem because they’re not paying their full tax liability.
The IRS has penalties for this mistake, so it’s never a good idea to underreport. Penalties may be the negligence penalty or the penalty for substantial understatement of your tax liability.
Remember that your taxable income is more than just what you make from your full-time job. You may have other income streams you need to report, whether investment income, side gig money, property sales, and more.
The IRS will be able to determine if you under reported income if they receive tax forms from third parties, like your clients, and the total amount doesn’t match what you reported on your tax return.
The agency uses its Automated Underreporter program to monitor for discrepancies in reporting. A CP2000 notice is sent to the taxpayer if a discrepancy is found, informing them that what was reported on their tax return doesn’t match IRS records. Talk to a tax attorney if you have questions about notice CP2000.
Protect Yourself From The IRS
If you’re facing an IRS audit, it’s important to understand how to respond effectively in order to avoid paying fees and other penalties.
Causes of Under Reporting Income
It may seem like the penalties involved with underreporting income aren’t worth the risk, but it does happen. Here is more detail on the two most common causes of underreporting:
To Pay Less Tax
One of the most common reasons people underreport is simple: They want to lower their tax liability. Paying taxes can be stressful for many taxpayers, and some have to get on a payment plan or other arrangement to afford what they owe. Unfortunately, underreporting income will only lead to more headaches and penalties.
Accidental Underreported Income Mistakes
Sometimes, the cause is a simple reporting mistake. A taxpayer may have accidentally under reported income because they left off a tax form or forgot about a project they were compensated for at the beginning of the year.
You need to report all income on Forms W-2, 1099-INT, 1099-MISC, and others you may get from third parties.
Accidental errors can still lead to penalties, but if you notice you made a mistake, let the IRS know right away and file an amended tax return.
It is never wise to underreport your income, even if you think you should be paying less tax. Underreporting and the subsequent underpayment can lead to interest charges, penalties, and even criminal charges in some cases.
Working with a tax expert is often helpful when taxes become complicated.
Did You Receive a CP2000 Notice from the IRS?
Anxious clients often call us at the Silver Tax Group after having received a “CP2000 Notice” (also known as an Underreporter Notice) from the IRS. Most often, they want to understand why they have received the Notice and whether it means they are in trouble. To answer the second question right up front: no, receiving an Underreporter Notice does not mean you are in trouble. However, it might mean you should seek the help of an experienced tax attorney.
Let’s take a look at what you should do if you receive a CP2000 Notice after filing your tax return.
What a CP2000 Notice Contains
Here’s the information a CP2000 notice typically contains:
|Discrepancy Information||The notice informs you of a discrepancy between the information the IRS received and the information reported on your tax return.|
|Proposed Taxes and Penalties||It proposes the taxes and possibly penalties you might owe for missing information.|
|Mismatch Explanation||The IRS sends Notice CP2000 when information on a tax return does not match the data reported to the IRS by third parties, such as banks, vendors, or employers.|
|Additional Income Source||The IRS will send you a CP2000 notice when they have additional income source information that was not included in your original tax filing.|
|Appeal Information||You have the right to contest penalties and appeal a CP2000 determination.|
|Response Requirement||It’s important to fully respond by the IRS deadline that is outlined in the document you recieved.|
4 Steps to Take When You Get a CP2000 Notice
The IRS will send you an underreported income notice if they find discrepancies in your earned and reported income. You can take steps right away if you find yourself in this situation. Here’s what to do:
1. Read the Notice Carefully
You first need to know exactly what happened. The CP2000 notice will tell you how the IRS came to the conclusion you underreported, including their sources of information and your tax return details.
2. Respond Right Away
It is critical to follow all instructions on the notice. Respond immediately or by the date indicated on the notice. There will be a notice form you need to complete, which states whether you agree with the IRS’s findings. You can either mail or fax your form to the address on your notice.
Agreeing with the form is the easiest option, as you will simply sign it and send it in, and then you will pay whatever you owe.
3. Submit Documentation if You Disagree
Disagreeing with the notice means you need to send in a signed statement that explains why you disagree. You also need to provide documentation to back up your claims, including corrected or missing tax forms.
4. Look for Mistakes on Other Returns
Sometimes a mistake uncovered by the IRS may appear on other tax returns, too. Look through past returns to make sure there aren’t any errors, and submit an amended tax return if you find something.
Remember: Never ignore a notice from the IRS. Doing so will only make your situation more complicated. Respond right away and follow the instructions on your CP2000 notice. You can also contact the IRS if there’s something you don’t understand on the notice.
Speak with a tax professional if you still have questions about what to do next.
Contact a Tax Expert With Questions About Unreported Income
Underreporting income is a big problem in the U.S., but don’t let it impact your life. Always report all income you earned for the year, even if it is not reported by a client or other third party who paid you. It is up to you to keep track of what you earn and report it properly to the IRS.
Tax laws can be complicated, and you may have a lot of questions about your responsibility, especially if you run a business or are concerned you accidentally underreported income on your tax return.
How an Experienced Tax Attorney Can Help With Underreported Income
Calculating and reporting your taxable income can get complicated (which is why it’s best not to try to prepare them on your own). Despite (or perhaps, because of) the thousands of pages of constantly-changing tax laws and regulations that determine your liability from year-to-year, questions can arise about what you need to report and how much you owe that do not have clear answers.
Sometimes, Underrerporter Inquiries call attention to those issues, and it takes a skilled legal advisor with years of experience representing taxpayers in matters involving the IRS to identify and obtain the most favorable resolution of the alleged discrepancy.
A tax attorney can, for instance:
- Assist in the investigation of the discrepancy, bringing detailed knowledge of current tax issues to bear in seeking and obtaining information that could impact how your Underreporter Notice gets resolved.
- Advise you when to dispute a discrepancy and when to agree to a proposed adjustment.
- Craft alternative proposals for resolving the discrepancy that may serve your interests more favorably than the resolution the IRS has proposed.
- Communicate and negotiate directly with the IRS on your behalf, saving you the time, energy, anxiety, and potential risk of handling complicated tax matters on your own.
- If and when necessary, represent you in legal proceedings aimed at resolving a discrepancy with the IRS that could not be resolved through negotiation.
Every matter we handle has its own unique facts. No matter what response is called-for in the case of your Underrporter Inquiry, however, an experienced tax attorney can protect your rights and serve your interests in any dealings with the IRS.
Summary & Key Takeaways
- Common examples of underreported income: It is important to provide examples of underreported income to help readers understand what they should look out for. Examples include: tips, rental income, cash transactions, freelance work, and investment income.
- Consequences of underreported income: Readers should be aware of the potential consequences of underreporting their income, such as paying penalties, interest, and even facing criminal charges.
- What to do if you receive an IRS notice: It is important to provide readers with steps they can take if they receive an IRS notice regarding their underreported income. This can include gathering all relevant documents, seeking professional help, and responding to the notice in a timely manner.
- Ways to prevent underreported income: Offer readers some practical tips they can use to prevent underreported income in the future, such as keeping accurate records, using reporting tools, seeking professional guidance, and being proactive in identifying potential underreporting.
- The importance of seeking professional help Remind readers that dealing with the IRS notice can be complex and stressful. Advocating for the enlistment of experienced tax professionals who can successfully navigate the complexities of an IRS audit.
Reach out to Silver Tax Group to speak to a tax expert about underreported income, the CP2000 notice, and any other tax questions you have.