What Happens If You Understate Your Income on a Tax Return?

Understating your income on a tax return, whether by mistake or intentionally, is a serious issue in the eyes of the IRS. When income goes unreported, the IRS sees it as an attempt to avoid paying the correct amount of tax. And once they find out, the consequences can be costly. If you’ve found yourself in this situation, it’s important to act quickly and look for some professional guidance.

1. Recalculated Taxes and a Bigger Tax Bill

The first consequence is often a corrected return from the IRS showing a higher amount of tax due. If you failed to include certain income like freelance work, investment earnings, or even cash payments, the IRS will add it back in and recalculate your tax liability. This means you could end up owing more than you originally reported.

2. Interest and Penalties

Once the IRS determines that you owe more tax, they begin charging interest on the unpaid amount from the original due date. On top of that, penalties may apply. The most common is the accuracy-related penalty, which adds 20% to the underpaid tax if the IRS believes you were negligent or made a substantial understatement. If they determine you intentionally tried to deceive them, they can impose a civil fraud penalty of 75%.

3. Risk of an Audit

Understating your income increases your chances of being audited. The IRS uses computer systems that match the income reported by employers, banks, and other payers with what you list on your return. If there’s a mismatch, it may trigger a formal review or audit of your return and sometimes it goes back multiple years. Audits are stressful, time-consuming, and can uncover even more discrepancies.

4. Forfeiture of Future Refunds

If the IRS finds out you owe additional taxes because of unreported income, and you don’t pay what you owe, they can apply (or “offset”) any future refunds toward your balance. So even if you’re owed a refund in later years, the IRS can take that money and use it to cover your outstanding debt without asking first.

5. Disqualification from IRS Relief Programs

The IRS offers programs to help people in tough financial situations, like Offers in Compromise or payment plans. However, these programs require full disclosure of your financial situation. If you’re caught understating your income, the IRS may see that as a sign of bad faith and it could disqualify you from getting help.

6. Possible Criminal Charges

While most cases of underreporting are handled with penalties and interest, willful tax evasion can cross the line into criminal territory. If the IRS believes you deliberately hid income through fake documents or shell companies, they can pursue criminal charges. Convictions may result in large fines or even jail time.

7. Damage to Your Reputation

For professionals, business owners, and tax preparers, being caught underreporting income can have long-term consequences beyond the IRS. It can damage your reputation, lead to loss of professional licenses, and make it harder to qualify for loans or other financial support.

Final Thoughts

Whether accidental or intentional, understating your income can have serious financial and legal consequences. The longer the issue goes unaddressed, the more complicated and costly it can become. Fortunately, there are ways to correct the problem and avoid the worst outcomes.

If you’ve received a notice from the IRS or realized that you may have underreported your income, don’t go through it alone. At the Law Office of Steven N. Klitzner, we help taxpayers in Florida resolve IRS problems, correct past tax returns, and negotiate affordable solutions without the fear of losing everything.

Chat with us today to schedule a free and confidential consultation. Let’s talk about how we can help you fix the issue before it gets worse.