Underreported income issues, part 1: the automated program

We live in a society that tries hard to find technological solutions to problems. This attempt is not always successful, but it has deep roots in the culture.

In tax compliance, one way in which the search for a technical solution is present is the Automated Underreporter Program (AUP). The AUP is an effort by the IRS to use computerized tools to detect underreporting of income on tax returns.

In this two-part post, we will inform you about how this program affects possible tax penalties for underreporting income.

Every year, the AUP program generally identifies more than 20 million tax returns where the income does not appear to match the amount reported to the IRS by third parties. These third parties include employers, financial institutions and others who file informational returns such as W-2s or 1099s.

Ideally, once an income reporting discrepancy is identified, human agents would look into the matter and try to resolve it without having to contact the taxpayer. But due to resource constraints, the IRS only investigates about 1 in 5 of the returns where the reported income doesn’t match up with the amount indicated by other sources.

As a result, in many cases the IRS sends out a Notice of Underreported income, also called a CP2000 Notice, without any human involvement.

Earlier this year, the Treasury Inspector General for Tax Administration (TIGTA) issued a report on how the AUP program is working and how it affects tax penalties for underreporting income. In part two of this post, we will discuss TIGTA’s findings.