What Happens if You Don’t Report a W-2?

Taxpayers have a fundamental obligation to report all income received to the Internal Revenue Service (IRS). The Form W-2, Wage and Tax Statement, is a crucial document that records an individual’s annual wages and the taxes withheld by their employer. The U.S. tax system relies on accurate income reporting to function effectively, ensuring fairness and compliance across all taxpayers. The IRS employs advanced systems to verify the accuracy of reported income.

How the IRS Knows About Your Income

The IRS possesses extensive capabilities for gathering income information. Employers are legally mandated to submit W-2 forms not only to their employees but also directly to the Social Security Administration (SSA) and the IRS. This submission typically occurs by January 31st each year for the preceding tax year, well in advance of individual tax filing deadlines.

The IRS utilizes computer matching programs, such as the Automated Underreporter (AUR) program, to cross-reference the income reported by third parties, like employers, with the income taxpayers declare on their federal income tax returns. This automated process identifies discrepancies where the income reported by an employer on a W-2 does not match the income reported by the employee on their Form 1040. The IRS frequently has knowledge of a taxpayer’s income before the taxpayer even submits their return, enabling them to flag potential underreporting.

Initial IRS Actions for Unreported Income

When the IRS’s automated systems detect a mismatch between income reported on a W-2 and the amount a taxpayer includes on their tax return, the typical first step is to issue a CP2000 notice. This notice, formally known as an Underreporter Inquiry, is generated when there’s a discrepancy between third-party reported income and what the taxpayer reported. The CP2000 notice is not an audit but rather a proposal of changes to the taxpayer’s income, deductions, or credits based on the information the IRS has received.

The notice details the identified discrepancy, including the third party who reported the income, the amount they reported, and the amount the taxpayer reported. It also calculates the proposed changes to the taxpayer’s tax liability, which may include additional tax, penalties, and interest. The CP2000 notice is primarily an informational letter from an automated system, indicating a potential issue that requires the taxpayer’s review and response.

Understanding and Addressing IRS Notices

Receiving an IRS notice, such as a CP2000, requires a timely and appropriate response. The notice will include a response form and specify a deadline, typically 30 days, by which the taxpayer must reply. It is important to carefully review the proposed changes and compare them against personal records, including all W-2s and other income statements.

If the taxpayer agrees with the IRS’s proposed adjustments, they can sign and return the response form, usually with payment if additional tax is due. No amended return is needed if the taxpayer fully agrees with the changes. However, if the taxpayer disagrees with the findings, they must formally dispute the IRS’s position by providing clear, documented evidence. This evidence could include proof that the W-2 was incorrect or documentation showing the income was already reported elsewhere.

In situations where the original return was indeed incorrect due to the unreported W-2, filing an amended return using Form 1040-X is often the correct action. Form 1040-X is specifically designed to correct errors on previously filed individual income tax returns, allowing taxpayers to update income, deductions, or credits. When submitting Form 1040-X in response to a CP2000, it is advisable to write “CP2000” at the top of the amended return and attach it behind the response form. Regardless of the response, keeping copies of all correspondence and supporting documentation is crucial.

Penalties and Interest for Unreported W2 Income

Failure to report W-2 income can lead to various financial consequences from the IRS. An accuracy-related penalty may be assessed, which is typically 20% of the underpayment attributable to negligence or disregard of rules. This penalty applies when there is a significant omission of taxable income from the return.

If the unreported income results in a failure to file a tax return at all, a failure-to-file penalty may apply. This penalty is usually 5% of the unpaid tax for each month or part of a month the return is late, capped at 25% of the tax due. Additionally, if the underreporting leads to an unpaid tax balance, a failure-to-pay penalty is incurred. This penalty is generally 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid, also capped at 25% of the unpaid taxes.

Interest also accrues on any underpayment of tax from the original due date of the return until the balance is paid in full. The interest rate is determined quarterly and is typically the federal short-term rate plus 3 percent, compounding daily. While penalties may sometimes be abated if the taxpayer can demonstrate reasonable cause for the underpayment, interest generally cannot be waived.