Failing to report income can result in severe penalties including fines and incarceration. Income from all sources must be accounted for and it is rare for the IRS to waive penalties on unreported income. The statutes allow the IRS to pursue unreported income for up to six years after the tax was due. Nationwide, it is estimated that unreported income may be as high as $370 billion per year.
How the IRS Finds Unreported Income
The IRS has numerous tools at their disposal to uncover and discover hidden income and the sources of that income. These include analyzing the individual’s financial accounts, bank accounts, tax returns, and e-commerce platforms. For individuals who are self-employed, the IRS may compare gross income and profit ratios to determine how much of the individual’s income was not reported properly. The IRS will look for discrepancies between deposits, withdrawals, and tax payments. The greater the discrepancies that are uncovered, the more scrutiny the IRS will exert in their investigation.
Civil penalties are typically applied if an individual understates the taxes that are owed. These can amount to as much as 5% for each month following the date the tax was due. This is limited to a maximum of 25%. Individuals who owe taxes on unreported income may request to pay their penalty in installments, however, these payments will continue to accrue interest until the tax debt is satisfied.
Penalties for fraud and deliberately attempting to hide income are much higher than for simply forgetting to report income. In cases where fraud and tax evasion are the motivating factors, the penalties can be as high as 75% of the amount due. Typically, the IRS does not pursue incarceration in cases where the taxpayer owes small amounts or attempts to pay the taxes owed prior to the launching of a criminal investigation.
Avoiding a Tax Audit
The best way to avoid a tax audit is to meet with a tax lawyer before the IRS sends notice that an individual is under investigation. A tax lawyer in Illinois can help prepare the necessary financial statements and tax forms to report the income to the IRS. Because the penalties for failing to properly account for income and file these forms can be significant, it is not something taxpayers who owe taxes on unreported income should do by themselves.
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