Underreporting income issues, pt 1: How does the IRS detect it?
Including all of your income when you file your taxes is easier said than done.
You may, for example, have multiple 1099s that become difficult to keep track of or income from a freelance job besides your main job (for which you received a W-2) It’s important to be aware that the IRS has ways of checking on the accuracy of the income you report.
In this two-part post, we will discuss how the IRS seeks to detect underreported income and what it does in response to possible underreporting.
The way the IRS generally knows about possible underreporting of income is through a method called matching. The IRS uses information it gets from other sources — such as informational returns filed by employers and banks – and compares the income reflected in those reports to the income on the return you filed.
The IRS does this through a program called the Automated Underreporter Program (AUP).
If there is a discrepancy, the IRS may follow up manually, through a human agent. More often, however, an AUP discrepancy will trigger a computer-generated notice called a CP2000 Notice.
This notice isn’t a bill. It is notice that the information you submitted doesn’t match what the IRS already has on file from other sources.
You do not necessarily have to amend your tax return when you receive such a notice. Indeed, you do not even need to agree that you underreported income. But you do need to respond.
In part two of this post, we will discuss when underreporting income can result in tax penalties or even criminal prosecution.