A taxpayer need not panic should he or she receive a CP2000 Notice about income underreporting, as long as they know how to handle the process properly.
In this article:
- What Is the IRS CP2000 Notice For?
- What Does the CP2000 Contain?
- Who Typically Receives a CP2000 Notice?
- How Does the IRS Find or View Income Underreporting?
- What Are the IRS Penalties for Underreporting Income?
- What Can Taxpayers Do?
Frequently Asked Questions About the CP2000 Notice
What Is the IRS CP2000 Notice For?
Most taxpayers feel dread whenever they receive a CP2000, as the notice may read like the start of a tax audit. But while rejecting the CP2000 does usually give rise to an audit, the IRS still gives the taxpayer a chance to explain their side first, so that both parties can avoid a lengthy tax audit process.
A CP2000 contains the newer tax amount, and also tax penalties applied retroactively. In the eyes of the IRS, the taxpayer did not pay the whole amount and other common penalties, like the failure to pay penalty and other tax underpayment fees.
A taxpayer receiving a CP2000 Notice would mean that the IRS found some discrepancies on the tax return filed. These discrepancies usually arise when clients or employers report their expenses to the IRS and the numbers between the tax returns do not match.
Upon receipt of the Notice of Possible Income Underreporting (CP2000), the taxpayer should reply within 30 days, or else the IRS considers the tax amount in the CP2000 as accurate. Since the tax amount retroacts effective the tax deadline, the penalties may grow even higher, as most of the fees apply on the first calendar day of the month, not after 30 days from receipt of the notice.
What Does the CP2000 Contain?
To summarize, taxpayers will see in their CP2000:
- The amounts they have reported, specifically gross income;
- Sources of the income, like clients, employers, or business profits;
- What the sources reported as the taxpayer’s supposed income; and
- The correct tax amount according to the IRS, plus penalties.
The IRS can claim that either the taxpayer did not report all the applicable income, or that expenses and deductibles are inaccurate.
It is important to note that the taxpayer has two choices, either to agree or disagree with the changes. The absence of a reply within 30 days may constitute approval of the new tax amount.
Tip: If the taxpayer agrees with the IRS calculation, do not send a new tax return. The IRS department that handles the receipt of tax returns does not work with the department in charge of income underreporting, and forwarding your reply may take additional time.
The delay from sending the new tax return may lead to non-receipt of reply for the IRS. If the taxpayer agrees with the CP2000, the notice has a form stating the agreement, and taxpayers should use that form instead of filing a new tax return.
Do note that CP2000, if left unpaid or unfiled, can lead to a tax levy or even wage garnishment. Once the taxpayer gives his or her reply, negotiations with the IRS proceeds as to the correct tax amounts.
Who Typically Receives a CP2000 Notice?
Around 83% of all lost income tax revenues in 2006 come from income underreporting. Individual taxpayers underreported around $122 billion, while non-business income tax, which comes from employees and freelancers, only reached $68 billion.
For 2012 and 2013, The IRS sent around 20,000 CP2000 notices to small enterprises, which caused a lot of panic for these mom-and-pop stores. However, self-employed taxpayers, as well as employees, can get the underreporting notice simply due to some possible misunderstandings.
For employees and independent contractors, misunderstandings and discrepancies between the tax returns can trigger the CP2000. For example, the employee sending a 1099 form while the employer sending a W-2, as well as the employer stating a lower salary expense for the worker, are some triggers, not just for income underreporting, but also employee misclassification.
Small businesses receive the bulk of CP2000, as income underreporting is a little more prevalent in these enterprises. Most often than not, the underreporting comes from lack of knowledge of proper tax processes rather than malice, which makes an affordable tax specialist immensely valuable for small businesses to have in their back pockets.
How Does the IRS Find or View Income Underreporting?
The IRS examines income tax returns by comparing the income reported between all parties, like the taxpayer, clients, and employers through the Information Returns Processing system (IRP). The IRP has a database of not only all income reported, but also standards and averages that calculates how “off” the reported income is compared to the historical average.
Remember, most of the IRS income underreporting notices received by taxpayers come from an automated system. The chances of misunderstood or erroneous information are high, so taxpayers should review the notice before replying.
Once a taxpayer replies, a live IRS agent reviews the paperwork. It may take 30 days or longer before the IRS tax agent sends a reply.
Tip: The IRS receives thousands, if not millions, of replies and operates under a “first received, first reviewed system.” Taxpayers should reply as soon as possible since the IRS treats income underreporting very seriously and takes time to manually check all information and even investigate the accuracy by reaching out to all parties.
What Are the IRS Penalties for Underreporting Income?
There are two classifications for penalties regarding underreported income. These categories are penalties due to negligence, and then penalties for tax fraud.
For underreported taxes, the IRS usually applies a .5% failure to pay fee of underreported taxable income.
If the taxpayer reports the underreported income due to ignorance of the law or a misunderstanding, the IRS applies a 20% penalty, which is on top of the failure to pay penalty. Proving good faith is crucial, and the IRS can even give penalty abatement, especially if this is the taxpayer’s first offense.
On the other hand, if the IRS auditor finds out that the taxpayer committed fraud, a hefty 75% penalty applies. In fact, some can go up to 100%, depending on the gravity of the fraud, as well as how much income was underreported.
Tax fraud and tax evasion can lead to hefty fines as well as imprisonment. Tax evasion can lead to 5 years of prison time, while assisting someone to evade taxes can merit 3 to 5 years imprisonment.
It is interesting to note the tax debts for convicted or imprisoned taxpayers. Less than 20% of all tax fraud cases relate to a tax amount lower than $100,000 and around 87% of imprisoned taxpayers due to fraud have a tax debt of at least $1.5 million.
Also, more than three-fourths, or 80%, of convicted taxpayers are first-time offenders.
What Can Taxpayers Do?
Upon receipt of the CP2000 Notice, the taxpayer can either accept or reject the tax amount using the forms attached in the CP2000.
Accepting the figures in the notice requires the taxpayer to also send the payment. However, installment plans are also available.
If the taxpayer rejects the figures, the IRS will review the information as well as the supporting documents the taxpayer sends. The IRS will send its decision usually after 30 days but possibly longer, and the taxpayer can appeal the decision.
For taxpayers who want to ask a live IRS agent, finding the nearest IRS or local tax center in your area definitely helps.
First-time offenders can ask for penalty abatement, provided that the underreporting is caused by negligence and not through fraud.
A CP2000 Notice is not final and even the first rejection by the IRS can be appealed. As long as the taxpayer makes informed decisions about their taxes, the process becomes easier and faster.
For further questions, please share them in the comments section below.
If you owe back taxes, visit taxreliefcenter.org for more information about tax relief options.