How Much Income Can Go Unreported to the IRS?

How Much Income Can Go Unreported to the IRS?

There is no legal amount of taxable income that you can “safely” get away with not reporting to the IRS. Even small mismatches can lead to additional tax, interest, and accuracy penalties. Taxpayers are legally obligated to report all income, no matter how big or small the amount is, and pay taxes accordingly, unless they qualify for a filing exemption.

If you didn't report all of your income to the IRS, don’t panic, as it’s unlikely you’ll go to jail for the mistake, but there are consequences.

Thankfully, there are also steps you can take to resolve issues before the IRS escalates to collections. Sometimes you can fix things yourself, but oftentimes, it helps to talk to a tax professional, especially if you’re dealing with years of underreported income or complex situations.

At Wiggam Law, we can help you file or amend the necessary tax returns and make payment arrangements. Learn how we help with unfiled returns.

Key Takeaways

• How will the IRS know about my unreported income? Information from third parties, such as financial institutions, crypto platforms, and employers.
• How much does it take for the IRS to discover unreported income? Even a minor discrepancy can trigger a CP2000 or a non-filer notice.
• Penalties: Not properly reporting income can result in penalties that range from 0.5% to 75% of the unpaid tax amount, plus interest, depending on why you didn’t report the income.
• Statute of limitations for underreported income: Three years from the date you file a return to assess additional tax, and six years if you underreported more than 25%.
• Be proactive to avoid serious trouble. The sooner you fix an income-reporting mistake, the less you’ll owe in penalties and interest, and the lower the risk of allegations of tax fraud.

How Does the IRS Know About Income I Don’t Report?

There are several ways the IRS can tell you’ve not been reporting part or all of your income. Here are some common ways:

• The Automated Underreporter (AUR): Even when you don’t report your income, the IRS still receives income reports under your Social Security Number (SSN) from third parties. When there’s a discrepancy between what you reported and what the third parties reported, the IRS AUR system flags your account. Third parties include W-2s, 1099s, 1098s, brokerage, and bank systems.
• Lifestyle audits: If your reported income doesn’t match your standard of living, such as listed mortgage payments or major assets, it can trigger an audit. Another way the IRS may end up on your tax account is by auditing your spouse's or business partners' accounts and finding inconsistencies that implicate you.
• Whistleblowers: This is rare, but the IRS also receives tips from the public, business competitors, or former associates who report underreported income and tax evasion.

What Counts as Underreported Income?

Underreported income occurs when the amount of income you report on your tax return is less than what the IRS has on file from gig platforms, employers, financial institutions, and other third-party sources.

However, the mismatch doesn’t always mean intentional wrongdoing; in many cases, the discrepancy stems from missing forms, simple errors, or side-hustle income that taxpayers didn’t realize needed to be reported. Common examples include:

• The taxpayer never got a 1099 and assumed their income was not taxable, or forgot to report the 1099 income.
• The taxpayer didn’t know they had taxable income. This could happen if the taxpayer experiences a financial gain from non-employment sources, such as gambling earnings, gig or payment-app payments, crypto, stock dividends, or interest.
• A third party mistakenly reports income to the IRS using the taxpayer’s Social Security number.

Penalties for Underreporting Income to the IRS

If the IRS discovers unreported income earned by the taxpayer, the taxpayer faces one or more of the following penalties.

Penalty	Penalty Amount
Failure to Pay Penalty	This is 0.5% of the unpaid tax amount for each month, or for the part of the month it goes unpaid. This penalty maxes out at 25%.
Accuracy-Related Penalty	The amount of this penalty is 20% of either the underpaid tax attributable to negligence or 20% of the underpaid tax amount when there’s a substantial understatement of income tax. A substantial understatement exists if the understatement exceeds $5,000 or 10% of the tax required to be reported, whichever is greater.
Civil Tax Fraud Penalty	The IRS charges a 75% penalty for the underpayment of tax amount attributable to fraud.

In addition to penalties, the taxpayer will still owe the unpaid tax and interest, which starts accruing from the date the tax should’ve been paid and compounds daily. As bad as these penalties can be, they’re not as bad as what could happen if the underreporting of income is criminal in nature.

However, most of these cases are resolved by simply responding to the IRS notices, providing documentation to correct the return, or making payment arrangements. Ignoring the notices can lead to aggressive IRS collection actions, such as levies, wage garnishment, and asset seizure, to name a few.

Is Underreporting Income Illegal? Mistakes vs. Tax Evasion

Intentionally failing to report taxable income to the IRS is illegal and could result in jail time for the taxpayer. But before you panic, understand that this rarely happens and that there are several reasons for it, including:

Most instances of underreported income are mistakes.

A key element of criminal liability is that the taxpayer must intentionally attempt to hide income from the IRS. Not understanding taxes, reporting, and payment requirements, or having a negligent disregard for tax requirements, usually isn’t sufficient to warrant criminal charges.

Proving criminal intent is difficult

The primary difference between civil and criminal tax fraud is intent. In other words, the government has to prove that the taxpayer knew they needed to report or pay a certain amount of income, but decided to report or pay a smaller amount. Rarely is there direct evidence of this, so the government has to rely on indirect evidence, such as taxpayers hiding money or keeping two sets of income records. This can be a difficult task for government prosecutors.

Many criminal tax evasion cases aren’t worth prosecuting.

It’s expensive to criminally prosecute a taxpayer. Therefore, the IRS isn’t likely to refer a case to the U.S. Department of Justice for prosecution unless there’s plenty of evidence to support charges for tax evasion and there’s a lot of money at stake.

Remember, the IRS isn’t interested in putting taxpayers in prison but in collecting unpaid taxes. Hefty tax penalties and the threat of collection actions are usually enough to get most taxpayers to make things right with the IRS.

How Long Can the IRS Go After Unreported Income?

The IRS usually has three years from the due date of a tax return (or from the date the IRS receives the return, whichever is later) to assess tax. This three-year deadline can be extended in certain cases, such as:

• The IRS filed a Substitute for Return (the three-year clock never starts running).
• The taxpayer agrees to extend the deadline by signing Form 872.
• The taxpayer omitted more than 25% of their income on their tax return (the three-year clock is extended to six years).
• The taxpayer filed a false or fraudulent tax return with the intent to avoid tax liability (there is no statute of limitations on civil tax fraud).

What You Should Do If You Underreported Income

This depends on when you discover the underreporting. Here are your options:

• File an amended return (Form 1040-X): If you discover you failed to list income on your tax return before the IRS sends you a CP2000 (which typically arrives months after a tax return), you can add the missing income or correct the errors on the previously filed return. This helps reduce the penalties and interest that would have accrued.
• Respond directly to a CP2000 notice: If the IRS already sent a notice and you agree with the IRS’s proposed correction, you can pay what you owe or make other arrangements to pay your tax balance, such as an installment agreement.
• Provide supporting documentation: If you don’t agree with the IRS calculations, submit records to show the income was reported incorrectly or the extra income doesn’t belong to you.
• Voluntary disclosure: This is for taxpayers facing potential criminal liability for willful non-compliance. If the underreporting was repeated or substantial, proactively correcting it can reduce potential penalties in criminal cases if the taxpayer reports before the IRS sends a notice.

Still Not Sure What To Do? Consider Talking to a Tax Attorney

If you notice a simple or small underreporting mistake, you can potentially fix things with the IRS on your own. However, if you’re dealing with a significant amount of unreported income, multiple years of unreported income, suspect you’re the victim of identity theft, or the facts of your case point to potential civil or criminal fraud allegations, it’s worth talking to someone from Wiggam Law.

You can arrange a consultation by calling us at (404) 609-1300 or using our online contact form.

Frequently Asked Questions (FAQs)

Here are some answers to some questions we get on unreported income:

Sources

1. https://www.taxpayeradvocate.irs.gov/get-help/issues-errors/underreported-income/
2. https://www.irs.gov/taxtopics/tc652
3. https://www.irs.gov/payments/accuracy-related-penalty
4. https://www.irs.gov/payments/failure-to-pay-penalty
5. https://www.irs.gov/irm/part9/irm_09-005-013
6. https://www.irs.gov/filing/time-irs-can-assess-tax
7. https://www.irs.gov/irm/part25/irm_25-001-006
8. https://www.irs.gov/pub/irs-pdf/p1035.pdf
9. https://www.irs.gov/forms-pubs/about-form-1040x