Underreporting Income: What to Know and How to Identify It

If you don’t know already, it is important to be aware that underreporting income on your tax return is considered income tax fraud, a crime that’s punishable by fines or potential imprisonment.

But what exactly is meant by underreporting income in San Francisco, CA? How does it occur, and where are you most likely to see it happen? Here’s an overview of what you should know.

About underreporting income

There are two common methods of underreporting income. The first is to simply tell the IRS you made less money than you actually did during the tax year. The second is a bit more complicated, and involves claiming deductions, tax credits and exemptions for which you do not actually qualify.

Underreporting income is the most common form of tax fraud and tax evasion in the United States. The tax gap, which is the gap between the amount of taxes owed and the amount actually paid, is inflated every year due to underreported income. One estimate from the IRS indicates more than 83 percent of the tax gap can be attributed to underreported income.

What might be surprising is that it’s individual tax filers rather than corporations that are the biggest culprits when it comes to underreporting income. More than 50 percent of the total tax gap, according to the IRS, exists due to underreported income from individual filers.

Of these culprits, the most likely category of individuals to underreport their income is business owners. Underreported business income accounts made up about 30 percent of the total tax gap in the same studies by the IRS. Non-business income, including normal wages and salary, only accounted for about 50 percent of the total money made up by underreported business income accounts, or about 15 percent of the total tax gap.

People who earn standard wages and salaries are generally more likely to pay their income tax bills, because their earnings are automatically reported to the IRS by their employers, who withhold their Medicare and Social Security contributions from their paychecks. If you are such an employee, you should know that the IRS receives a copy of your W-2 as well. As such, it is not particularly surprising that only one percent of all income from standard wages and salaries was underreported in the IRS study. It was people with no third-party reporting (in other words, self-employed workers and small business owners) who were much more likely to underreport.

What are the consequences?

The consequences of underreporting income depend on your intentions. If your non-compliance with tax law was simply due to a mathematical error or ignorance of certain aspects of the tax code, this is considered negligence. You might be penalized for the mistake, but you probably will not face criminal charges.

However, if the IRS is able to prove you knowingly underreported income as a means of circumventing tax law, you could face felony charges and significant consequences.

To learn more about the penalties for underreporting income tax fraud and for help avoiding underreporting in San Francisco, CA, contact Medina & Company Consulting, Inc. today.