Income that is underreported can draw Internal Revenue Service (IRS) attention. An omission of gig wages or bonus money can create a discrepancy between your tax return and information reported to the IRS. Here is what you need to know about income that does not make it onto your tax return by mistake or by design.
What is underreported income?
Underreported or unreported income is income that should be reported on your tax return but does not appear there. Our tax group often works with clients facing tax audits and allegations of willful tax evasion. From handling both civil and criminal matters, we have seen how underreported income can arise from both intentional conduct and simple mistakes.
Along with civil and criminal matters involving payroll taxes, the IRS doubles down on practices that contribute to the tax gap. Failure to report income boosts the tax gap, the amount of money owed but not paid to the government.
Why underreported income matters to the IRS
Underreporting is the largest component of the tax gap. Of all underreported income, the category that most challenges the IRS is income paid directly to taxpayers outside traditional reporting channels. While W-2 forms verify employment income, money earned on the side, on the sly, cash transactions, and under the table is more difficult to track.
Not surprisingly, income that is subject to third-party reporting and withholding has a much higher compliance rate. With the rise of side hustles, a lot of people may have income from multiple sources, and income subject to little or no third-party reporting can be hard for the IRS to track.
Not so fast—how the IRS identifies underreported income
Failure to accurately report income that has also been reported to the IRS can quickly draw IRS attention. For additional background on how audits work, download our resource guide, A Tutorial on IRS Audits.
The best way to avoid mistakenly underreporting your income is to be aware of what you are required to report. According to the Tax Advocate Service (TAS), some lesser-known examples include:
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Income from forgiveness of a debt
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Income from goods or services paid through third-party payment platforms such as Venmo or PayPal
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Distributions from retirement accounts
If information reported to the IRS does not match the income reported on your return, you may receive Notice CP2000, which explains the discrepancy and proposes changes to your return. You can return the form agreeing with the proposed changes, or you can respond with additional documents and information if you disagree. Ignoring the notice is a bad idea. Failure to respond can lead to additional IRS action, interest, penalties, and a larger problem down the road.
Questions about underreported income or an IRS audit
If you receive a notice of deficiency or IRS audit letter, speak with our tax lawyers. At Robert J. Fedor, Esq., L.L.C., we provide experienced legal counsel on options that can help you navigate IRS inquiries or manage a potential criminal tax allegation. Contact our legal team at 440-250-9709. We serve clients internationally and throughout Northeast Ohio, Chicago, and New York City from our offices in Cleveland and Chicago.
