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Posted On August 14, 2016
Underreporting income, part 2: What are the consequences?

Underreporting income, part 2: What are the consequences?

Let’s continue the discussion of underreporting income issues that we began last week.

In part one, we focused on how the IRS seeks to detect underreported income and the notice it typically sends after detecting possible underreporting.

In this part of the post, let’s look at the possible consequences for underreporting income. Can you be hit with tax penalties or even criminal investigation for tax evasion?

Here is the key point: for small errors that weren’t deliberate, the IRS generally has a policy of not imposing strict penalties.

Last year, the Inspector General for Tax Administration (TIGTA) looked into the question of how the IRS’s Automated Underreporter Program was working in getting taxpayers to report all of their income. Part of TIGTA’s analysis concerned tax penalties for underreporting income.

There are actually two slightly different penalties. One is for “substantial” underreporting (defined as understating the tax owed by at least 10 percent). There is also a negligence penalty, which does not have a particular threshold.

Under the law, a taxpayer can avoid either of these penalties by showing that there was a valid reason for underreporting.

TIGTA found that the IRS often waives tax penalties for underreporting, especially when the taxpayer has a previous track record of compliance.

This certainly does not mean that you should become complacent about the accuracy of your return. Moreover, there are of course some cases where underreporting is such that it raises the prospect of criminal investigation for tax evasion.

If you face trouble with the IRS about underreporting, it is therefore good to discuss your situation with a knowledgeable tax attorney.