A CP2000 form is a letter sent by IRS when the income and/or payment information IRS has on file does not match the information you reported on your tax return. This could affect your tax return; it may cause an increase or decrease in your tax, or may not change it at all.

The CP2000 is a computer-generated letter that alerts you about a discrepancy between the information on your tax return and some third party information. You must respond to the IRS’ CP2000 letter by the due date. There is limited time to respond to the CP2000 notice, especially if you disagree with the proposed changes to your return. Your failure to respond to the IRS before the deadline will result in the IRS closing the audit and confirming the proposed changes.

For the purposes of income taxes, “income” is generally defined as all income from whatever source derived. A brief list of items IRS characterizes as income includes, but is not limited to, wages; salary; commissions; fringe benefits; gains from the sale of real property; interest; rents; royalties; dividends; alimony; annuities; pensions; income from life insurance, estates, trusts, or a discharge of indebtedness.

Individuals may be liable for certain taxes, such as federal and state payroll taxes. State sales taxes can be assessed against nonowners when you are in a position of financial authority and you pay vendors instead of the IRS or the state of California.

Yes, there is a procedure to assess business taxes against an individual who is an officer or a lower level employee. The IRS and the State of California are required to provide notice and give you time to oppose the assessment. Normally, after IRS has begun interviewing company employees, they will send out letters proposing an assessment on individuals who have requisite authority in the company. Individuals who receive a letter will have 60 days to respond to the IRS letter. In recent years, IRS letters have proposed a trust fund tax penalty on officers regardless of their job function. In cases where the individual was responsible (i.e. the person was the only one managing the day-to-day business operations), there are various options to resolve the expected tax liability.

California is focused on the “underground economy.” This term refers to businesses who are negligently or intentionally avoiding paying taxes. For instance, there has been an epidemic of workers who have been misclassified as independent contractors when they are truly employees. Business owners, officers and directors involved in the payroll process and accounts receivable for misclassified workers may be held responsible and receive devastating consequences. On January 1, 2012, California passed a new law that imposes a $5k minimum penalty for anyone who incorrectly advises a company to incorrectly characterize a worker as an independent contractor. The penalty can apply to lower level employees and even outside consultants such as bookkeepers and CPAs.

Currently, California’s government agencies are forming a task force to share information across agencies including between the Board of Equalization and DMV, or the BOE and FTB in order to identify underreported income.

The IRS has developed an algorithm called a Discriminant Inventory Function System (or “DIF”) that is used to score a tax return and determine which return to pull for an audit. The chances of being audited increase with various factors, including but not limited to the following:

• Income level (higher income earners have an increased chance of being audited; the average audit rate is about 1.03%; individuals earning over $200k have an audit rate of 3.70%)
• If you omitted income (your income from a partnership reported on your K-1 doesn’t match your reported income on your return)
• The types and amount of deductions or losses claimed
• The business you are engaged in
• If you own foreign assets (unreported foreign bank accounts or foreign income)

The Treasury Inspector General conducted a study in 2007 that showed 332,615 high- income taxpayers received the greatest benefit by potentially avoiding approximately $1.9 billion in taxes for Tax Year 2005. According to the Treasury Inspector General’s 2007 report, “[I]ncorrect deductions of hobby expenses account for a portion of the overstated adjustments, deductions, exemptions, and credits that result in about $30 billion per year in unpaid taxes.”

• The IRS can run a credit report for taxpayers who owe the government money.
• The IRS can summon bank records (bank statements, checks written, checks deposited) without a court order.
• The IRS requires taxpayers to report income from illegal activities.
• There is no time limit for the IRS to audit a fraudulent return or failure to file a return.
• The IRS has a department called Taxpayer Advocate Service to help taxpayers resolve disputes with the IRS where the taxpayer is not being treated fairly. This is not a substitute for legal representation; it is to resolve an internal issue with the IRS.
• Fraud penalties and payroll taxes are not dischargeable in a bankruptcy.

If you use a portion of your home for business, you may be able to take a home office deduction. The IRS has identified a checklist to see if you qualify for the deduction. A brief summarization is provided below:

• Is the space used exclusively and regularly for business purposes?
• Is your office the principal place where you conduct your business?
• Do you use your office as a place to conduct meetings or meet with clients?
• Is the business portion of your home a separate structure?

Generally, the amount that may be deducted is related to and based on the percentage of your home that is used for your business (this is done by dividing the square footage of your office by the total area of the home or by dividing by number of rooms in the home if all the rooms are about the same size). There are special rules that apply to daycare provider or individuals who utilize space in their home for storage of business property.

Businesses in general are responsible for paying various taxes: income tax, self- employment tax, excise taxes, property tax and other state and local taxes. How federal income taxes apply to small business depends on the type of business entity. While there are a range of potential tax issues, some “common” examples that serve as the basis for an IRS audit include: analysis of unreported business income; legitimacy of business deductions; whether a business qualifies as a business or a hobby; substantiation for the amounts reported on a tax return as business expenses; and classification of a worker as an independent contractor versus an employee.

Additional payroll tax may be assessed by IRS because an employer may have incorrectly categorized a worker as an independent contractor where that person is really performing services as an employee. Generally, independent contractors receive a Form 1099-Misc. and are responsible for paying self-employment tax and income tax. Employees, on the other hand, receive a Form W-2 and the employer is responsible for withholding income tax from the employee’s paycheck. With respect to the employee versus independent contractor classification, IRS will often examine the employer’s employee roster as well as the job duties and responsibilities, work schedules, and other information to make a determination.

With respect to business income, IRS will review all your business income, usually by examining your bank records and tax returns. IRS’ review of a company’s business expenses generally involves a determination of whether each expense meets the legal definition of an ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

A business or individual may request an offer in compromise. Essentially, this is a settlement offer requesting IRS to accept a lower amount than what is owed to them. This application is very extensive and should be prepared by an experienced tax professional with business experience. Do not take action until you have secured the assistance of a professional. Other options include an installment agreement. For the State of California, an offer in compromise is not available unless the business is closed and dissolved.

If you have received a notice of deficiency – sometimes referred to as a 90-day letter – act immediately. This letter is a legal notice sent by IRS confirming the proposed changes to your return. IRS generally makes changes that result in additional tax liability against you. The Notice of Deficiency is prepared by IRS at the close of an audit. You have 90 days (from the date of the letter) to file a claim in U.S. Tax Court to dispute the proposed assessment.