Unreported income is a significant issue for the IRS. The agency estimates that the United States loses billions of dollars in tax revenue each year due to unreported income. Given the scale of this loss, it is not surprising that the IRS has established procedures to identify unreported income.
Taxpayers who fail to report income on their tax returns will have additional tax to pay with interest and can also face significant penalties. Depending on the amount of unreported income and their intent, they can even face criminal prosecution.
Here are some methods used by the IRS to identify unreported income.
1. Information Matching
- Forms W-2 and 1099: Employers and businesses report income on W-2s and 1099s, which the IRS cross-checks with your tax return. Discrepancies can raise red flags.
- Form 1099-K: Payment platforms like PayPal and Venmo report transactions that meet certain thresholds, which the IRS compares to your filings.
2. Bank and Financial Records
- The IRS can access bank records during audits or investigations. Unusual deposits, large cash transactions, or transfers inconsistent with reported income may trigger scrutiny.
3. Automated Systems
- The IRS uses algorithms to identify mismatches or unusual income patterns. If your income is significantly lower than others in similar professions or industries, it may prompt a closer look.
4. Audits
- Random audits or those triggered by discrepancies allow the IRS to examine financial documents, receipts, and other records to verify reported income.
5. Whistleblowers
- The IRS offers incentives to individuals who report tax evasion. Information from employees, business partners, or other sources can lead to investigations.
6. Lifestyle Monitoring
- The IRS may investigate if your spending habits (e.g., luxury purchases, high-value assets) don’t align with your reported income.
7. Data Sharing
- Federal and State Collaboration: The IRS works with other agencies to exchange data and identify unreported income.
- International Agreements: Programs like FATCA require foreign institutions to report U.S. account holders’ financial activity.
8. Voluntary Disclosures
- If someone involved in a financial arrangement reports their underreporting, it could implicate others tied to the same income source.
9. Public Information
- The IRS can review publicly available information, such as social media or public records, to identify potential discrepancies between lifestyle and reported income.
10. Cash-Intensive Businesses
- Businesses that handle significant cash transactions are closely monitored. The IRS may analyze deposits and use undercover operations to verify compliance.
11. Bank Secrecy Act Reports
- Financial institutions file reports, such as Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs), for unusual or large cash transactions, which the IRS reviews.
East Coast Tax Consulting Group Can Help
Accurately reporting all income is crucial to complying with tax laws and avoiding issues with the IRS. Understanding how the IRS identifies unreported income can help taxpayers maintain proper records, file complete and accurate returns, and resolve any discrepancies before they escalate. If you’re worried about how unreported income might affect you or are uncertain about any part of your taxes, seeking advice from the qualified tax professionals at East Coast Tax Consulting can provide the clarity and guidance necessary to keep you on track.