In an ideal world, all taxpayers accurately report their income and pay all of their taxes. However, despite the risk of financial and criminal consequences, incidences of underreported income continue to occur, with the IRS estimating that up to 50% of tax returns do not include all taxable income.
Underreporting income can be done in a variety of ways, including being paid “off the books,” bartering, and not reporting sources of income like tips, dividends, and rental income.
If you’re wondering, “How does the IRS find out about unreported income?” keep reading to discover the answer.
If there are any hints of financial discrepancies between what’s reported on a tax return and what the IRS suspects you’ve earned, you can expect an audit notice. The question becomes, how does the IRS find out about unreported income in the first place?
As technology has advanced and the IRS has recently been approved for a significant budget increase, the ability of the tax agency to detect underreported income could improve.
Depending on what income has been underreported and how you fill out your tax return, the following methods can be used by the IRS.
Individuals and businesses alike are required to file taxes, so even if you don’t report income, a person or business that paid you could report that income to the IRS via different forms, W-2 and 1099 forms.
When these forms are filed by the other party and you fail to report them, the IRS may detect an issue with your tax information reporting and dig deeper.
Though most taxpayers have a low risk of being audited, the IRS does select a certain number of tax returns to be audited each year. During an audit, any underreported income can definitely be detected.
In providing information like financial records, bank statements, and other documentation related to income, the IRS will try to verify the income you’ve reported versus what you’ve actually earned.
The IRS has had analytics software for decades, and with the advent of AI (Artificial Intelligence), the detection methodologies have become even more advanced, so this is another key answer to the question of how does the IRS find out about unreported income.
Typically, the IRS will aggregate data to look at patterns and trends, identifying a tax return that is an outlier. For example, if the average business owner deducts $100 in meals in entertainment per week, but a tax return indicates a deduction of $900, that could be a red flag that triggers an audit to investigate further.
IRS investigations can also begin when another party reports a taxpayer who has underreported their income. In fact, the IRS even incentivizes whistleblowers in certain situations.
This means that if a colleague, employee, business associate, or other insider is aware that income is being underreported, there is a risk that the IRS will find out about it from one of these people.
If someone is making large-scale purchases that don’t align with their reported income, then it can lead the IRS to suspect that the income has been underreported. Specifically, purchases like homes, luxury cars, and other assets may be reported to the IRS.
If an investigation has been launched, the IRS may look into social media accounts and other available public information to gather additional evidence.
People can be surprised when they find out the answer to the question of how does the IRS find out about unreported income includes so many options. To request a tax consultation, contact Levy & Associates, Inc. at 313-447-1704 or contact us online.
Levy & Associates is available for free initial consultations. We’re happy to answer any questions you have about the audit process or address any concerns about your specific situation.
There’s never a good time to be audited, and the time-consuming process will take away from your business or family if you try to face it alone. Let us handle and coordinate communication, so you can return to your daily life.