Income an Employer Should Have Reported as Wages: What to Do

Employers must accurately report employee wages to the IRS and other tax agencies, but mistakes happen. Misclassified or underreported income can create tax issues, affect Social Security benefits, and complicate loan applications.

If you suspect an error, addressing it quickly can prevent financial and legal complications.

How Wages Are Generally Reported

Employers report wages through payroll records, tax filings, and official documents. The most common is the W-2, which details total earnings, tax withholdings, and Social Security and Medicare contributions. Employers must send this form to both the IRS and employees by January 31 each year.

Additionally, employers file Form 941 quarterly with the IRS to report payroll taxes. Independent contractors receiving over $600 are reported on Form 1099-NEC instead of a W-2.

State agencies also require wage reports for unemployment insurance and workers’ compensation, often on a quarterly basis.

Common Causes of Reporting Mistakes

Errors often stem from administrative oversight, payroll system issues, or misinterpretation of tax rules. One common mistake is failing to classify taxable compensation correctly, such as housing allowances or personal use of company vehicles.

Payroll processing errors, including data entry mistakes or software transitions, can also cause discrepancies. Misclassifying employees as independent contractors shifts tax responsibilities unfairly.

In some cases, employers intentionally underreport wages to lower payroll taxes. This can harm employees by reducing Social Security benefits, affecting unemployment insurance, and making it harder to verify income for loans or assistance programs.

Rectifying Misclassified Earnings

Correcting wage errors involves gathering evidence, submitting corrections, and working with tax authorities.

Gathering Official Wage Information

Employees should request pay stubs, W-2 forms, and year-to-date earnings summaries from their employer. Comparing these to bank statements and Social Security records can help verify actual earnings.

If an employer refuses to provide documentation, employees can request a wage transcript from the IRS using Form 4506-T.

Filing Correcting Forms

If wages are underreported, employees may need to file corrections with the IRS. Form 4852 serves as a substitute for a missing or incorrect W-2, requiring employees to estimate earnings and tax withholdings. If a corrected W-2 (Form W-2c) is later issued, employees should amend their tax return using Form 1040-X.

For misclassified independent contractors, Form SS-8 can be submitted to the IRS to determine employment status. If reclassified as an employee, the employer may need to issue a W-2 and pay payroll taxes.

Communicating With Tax Agencies

If an employer refuses to correct wage errors, employees can report the issue to the IRS using Form 3949-A for suspected tax fraud. State labor departments or tax agencies can also be contacted if the issue affects unemployment insurance or state tax withholdings.

The IRS may investigate and penalize employers who fail to report wages correctly. Employees should also notify the Social Security Administration if earnings records are incorrect, as this affects future benefits. If an employer fails to provide a W-2, the IRS may use available data to estimate tax liability.

Potential Tax Consequences for Employees

Misreported wages can lead to unexpected tax liabilities, interest, and penalties. If the IRS finds a discrepancy, it can assess back taxes and failure-to-pay penalties, which accrue at 0.5% per month, up to 25% of the unpaid tax. Significant underreporting—generally exceeding 10% of total tax liability or $5,000—may result in a 20% accuracy-related penalty.

Errors can also impact eligibility for tax credits and deductions. Income-based benefits like the Earned Income Tax Credit (EITC) and Additional Child Tax Credit (ACTC) depend on accurate wage reporting. If income appears lower than it actually was, employees may receive credits they don’t qualify for, risking audits and repayment. Conversely, if misclassification results in higher taxable income, employees may lose deductions such as student loan interest or IRA contributions, which phase out at specific income thresholds.

When Additional Professional Input May Be Needed

Some issues can be resolved directly with an employer, but complex cases may require tax professionals or legal experts. If an employer refuses to correct wages or tax fraud is suspected, consulting a tax attorney or CPA can help determine the best course of action.

Tax professionals can assist with amended returns, IRS notices, and penalty negotiations. If misclassification as an independent contractor results in significant tax liabilities, an employment law attorney may be necessary. If multiple employees are affected, legal action may be an option.

For Social Security concerns, employees should contact the SSA to correct earnings records.

Documentation to Keep

Maintaining records is crucial when addressing wage discrepancies. Employees should keep pay stubs, direct deposit records, and any correspondence with their employer.

Tax documents, including W-2 forms, tax returns, and IRS correspondence, should be kept for at least three years, as the IRS typically has this period to assess additional taxes. If fraud or substantial underreporting is involved, records from up to six years may be reviewed. Employees filing corrective forms should retain copies of all submissions and responses.