A Look at the IRS Automated Underreporter Program

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A Look At The Irs Automated Underreporter Program
A Look At The Irs Automated Underreporter Program
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The IRS uses a computer matching system to make various tax adjustments. The IRS refers to this as its automated underreporter program. This program adjusts millions of taxpayer accounts each year. The program generally goes unnoticed, until there is a problem. The Newman v. Commissioner, T.C. Memo. 2016-125, case provides an example of how this program can go awry.

Facts & Procedural History

Newman opened a checking account at Bank of America. The checking account was subsequently overdrawn and closed. Newman did not pay the bank for this overdraw account. The bank issued a Form 1099-C to Newman reporting the discharge of indebtedness income or COD income. Newman did not report the COD income on his tax return.

The court case does not chronicle the procedural history, but it no doubt involved the IRS’s automated underreporter program. This program is used by the IRS to adjust taxpayer accounts by matching information returns provided to the IRS by third parties to the taxpayer’s income tax returns. The intent is to catch items of income that taxpayers did not report on their returns.

The specific steps in this process are as follows:

  • The IRS’s computer system matches the third party information return against the taxpayer’s income tax return.
  • An IRS technician reviews the computer matching and decides the computer matching was correct.
  • The IRS technician sends the taxpayer a Notice CP2000, We Are Proposing Changes to Your Tax Return.

The taxpayer’s account is then noted with a collection hold pending a response to the IRS audit.

Taxpayers are not surprised to learn that the IRS has this type of program. But they are surprised to learn that the IRS entrusts its computer and lower level employees to wield this power without further review. It does. And the program works for the most part. It has been our experience that the program makes correct adjustments in many cases.

The program is not without error, however. It has been our experience that the program makes erroneous adjustments. Many of the erroneous adjustments seem to relate to factual issues that are not be self evident from the information forms the IRS receives from third parties or the taxpayer’s tax returns.

The Newman case provides a good example. Newman was insolvent in the tax year in question. There is an exception for COD income that says that insolvent taxpayers do not have to report or pay tax on COD income. There is no box to check on the Form 1099-C for this–nor would the third party generally know whether this exception applied. There is also no box on an income tax return to report that this exception applied. Also, the Notice CP2000 may not have explained that this exception could apply. This means that Newman had to respond to the Notice CP2000 to prove that the exception applied and he had to know that there was such an exception. This highlights two of the problems taxpayers often face when trying to resolve IRS tax troubles caused by the IRS’s automated underreporter program.

The IRS’s Automated Underreporter Program Puts The Burden On The Taxpayer To Show That Their Position Is Correct.

The taxpayer is guilty until proven innocent if you will. If a response is not received and processed by the IRS service center in the time specified in the notice, the IRS system will automatically make the adjustments provided in the notice. If the taxpayer does not act quickly, the adjustments will be presumed correct and the taxpayer may even lose his ability to get the issue resolved at the administrative level. The taxpayer may find their account as an unpaid tax debt assigned to the IRS collection function.

The IRS’s automated underreporter program also requires the taxpayer to figure out why the notice was even sent. This may not be as easy as it sounds. The Notice CP2000 may not provide any real explanation for the adjustment. The notice may not provide any explanation at all. This can be particularly troubling in situations where the taxpayer did not receive a copy of the third party information return or the taxpayer received quite a few information returns.

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