The last thing you want is to get in trouble with the IRS—but many find themselves in the hot seat every year, having failed to accurately report all of their income. If the IRS finds a discrepancy between your records and the payment information on file, they will first send you a CP2000 Notice, giving you a chance to prove there has been a mistake and correct the situation. Penalties—from civil to criminal, depending on the situation—may await the taxpayer who fails to report his or her income accurately.
In addition, the IRS is getting much better at catching misreported returns, thanks to electronic means of tracking income and comparing forms 1099-K (Payment Card and Third Party Network Transactions) to business returns. The most likely taxpayers to underreport are high-income individuals and small businesses, so if you fall into either of those categories, you may also be more likely to be selected for a face-to-face audit.
The best way to ensure that your tax return is up to snuff is to examine your records as the IRS will—with a keen and discerning eye for the details. There are several specific areas the IRS will look at right away, so before you file, make sure you do the following:
1. Review your bank records. Do your deposits line up with your reported income? Add up the total deposits for all of your bank accounts and compare that to your reported income and look closely at any inconsistencies. If your deposits are greater than reported income, consider whether you’ll need to report the difference as income or whether you can prove that some deposits are non-taxable (e.g., gifts or loans). Be ready to answer any questions your tax professional or the IRS might ask.
2. Double-check all information statements. Because the IRS now uses an automated process to compare information statements with their matching returns, even minor slip-ups in this area are easily caught. For example, if you’re a small business who receives a 1099-MISC from a customer, the total amount of payments on that statement need to match your own records.
3. Report income from website activity. If you conduct any kind of e-commerce through a website (such as selling a product or conducting online auctions), the IRS is likely to zero in on the details. Make sure you are reporting every bit of income—including website advertising sales and fees generated by selling customer lists to referral partners, two examples of “hidden” income that are more heavily scrutinized in an audit.
If you think you may have unreported income, ask your tax professional. And when in doubt, take the time to double-check everything. A little extra work now can save you quite a bit down the road.