Tax season is officially upon us! It’s this time of year that I often receive panicked questions from clients telling me they’re being audited by the Internal Revenue Service (IRS) because they underreported their income. This is never a fun situation for anyone. But there are ways to handle the situation so it’s not too overwhelming. Here’s what you should do if the IRS is auditing you for underreported income.
The first thing that happens in the audit process is you will receive a letter from the IRS. Make sure this is from the IRS and not another agency, such as the Franchise Tax Board, Employment Development Department (EDD) or the California Department of Tax and Fee Administration (CDTFA).
If the IRS believes you underreported income on your tax return, you will receive an underreporting notice, generally called a CP2000 notice. While this notice is technically not a notice of audit, it often serves the same purpose. The IRS sends this out if there is a discrepancy or mismatch between the income you reported on your tax return and the information your employer or contractor (if you’re an independent contractor) provided on its Form 1099 or W-2.
The CP2000 notice includes taxes and possible penalties that you owe for not reporting income on your tax return. If you receive a notice, it’s important you respond by the IRS deadline. That being said, it’s important to consult with a tax professional who has experience with underreported income before automatically complying with the IRS. There is a chance you may not owe money, or even the full amount indicated. But only a tax professional can determine this for you. For example, if a piece of property is sold, the income will generally be reported to the IRS. However, the IRS will not have the basis amount (any information regarding what you paid for the property or any improvements that you made). As the taxpayer, you need to provide the additional information or you may be taxed on the full sale price.
To determine whether you actually owe the IRS underreported income, you’ll need to prepare a few items before you meet with a tax professional. First, gather all your W-2s and Form 1099s, and compare the income reported on those documents to your tax return for the year in question to make sure the amounts match.
Even if you find a discrepancy in what you reported, let your attorney determine whether the amount is correct and if the IRS’ proposed amount is reasonable. If you plan to contest what the IRS says you owe, a response will need to be prepared and sent back, along with supporting documents by the deadline provided. Your attorney can help you prepare the response and assist you in requesting an installment agreement if you cannot pay the amount in full.
Getting an audit notice from the IRS is scary. But just because the IRS indicates you underreported income and owes money, does not mean it is a black-and-white situation. An experienced attorney will help remedy the situation so that you, the taxpayer, is protected and receives the best possible outcome.
Allison Soares is a partner and tax attorney at Vanst Law. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits.