IRS Notice CP2000: What It Is and How to Respond
IRS Notice CP2000 is the Notice of Underreported Income. The IRS typically sends this notice via certified mail.
The IRS sends out this notice when it believes there is a discrepancy between 1) the tax return you filed and 2) information reported to the IRS on tax forms such as W-2s and 1099s that were issued to your Social Security number.
For example, in a recent CP2000 Notice the IRS issued one of our clients here at Choice Tax Relief, the IRS was proposing an assessment because our client did not report several of his cryptocurrency transactions that were reported on Form 1099-B issued by BlockFi.
Our client didn’t report any of these BlockFi transactions on his return because they weren’t taxable since his cost basis equalled his proceeds on the 1099-B. The IRS, however, didn’t know this — and so they sent him a 1099-B proposing an assessment on over $50,000 of unreported income.
We, of course, were able to get this corrected by responding to the CP2000 by the deadline in the notice — more on this later.
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How Soon After a Return Is Filed Does the IRS Issue Notice CP2000?
CP2000s generally start appearing approximately nine to 15 months after a return is filed if the IRS detects a discrepancy.
And if not responded to within 30 days, the Notice CP2000 will typically be followed by the Notice CP3219A, which is a statutory notice of deficiency that I will discuss in another article at some point.
IRS Notice CP2000 At a Glance
|Notice Type:||30-Day Letter|
|Generated By:||IRS IRP|
|Followed By:||Notice CP3219A|
|Recommended Action:||Take Corrective Action or Pay Balance|
When the IRS Sends Notice CP2000
The most common reason for the IRS sending you a CP2000 Notice is when the following things happened:
- You filed a tax return for the year in question.
- When processing the return, the IRS discovered a discrepancy between information you reported on your tax return and information reported to the IRS on tax forms such as W-2s, 1099s, K-1s, etc.
Note that sometimes, taxpayers actually do report all their income report on their tax forms, but they report an item of income on the wrong line on their tax return — for example, reporting dividend income on the interest income line. Such errors will also likely trigger a CP2000 Notice from the IRS.
What You Should Do If You Receive a CP2000 Notice
Below are the steps you should take after you receive a CP2000 Notice.
1. Make sure you actually earned the income that the IRS is claiming you did not report.
Go through the “Explanation of changes to your Form 1040” section and review, line by line, every item of income in this section and ask yourself, “Did I actually earn this income?”
For example, if under “Explanation of changes to your Form 1040,” you see that the IRS has record of receiving two Forms 1099-NEC issued to your Social Security number totaling $23,680 between the two of them from a company called Complete Pest Elimination Inc., but you never received any money from Complete Pest Elimination Inc. during the year or you received less than $23,680 from Complete Pest Elimination, Inc. during the year, you need to take that up with both the issuer of this 1099 and also with the IRS.
So starting here, you’re going to be making a list of things that:
- you need to take up with the IRS in the letter you’re going to write them in response to the CP2000 and
- you need to take up with other parties, primarily entities that issued you erroneous tax documents.
Obviously if you didn’t actually earn the income reported on the 1099-NEC or at least not all the income that was reported on the 1099-NEC, then the tax form the IRS is looking at and based on which it is proposing to assess an additional liability against you is erroneous and the IRS is overcalculating your tax liability. And no one’s going to fix it other than you (or your representative).
So this is the first step — review the income the IRS is saying you didn’t report, compare it to your own records, and if there are discrepancies, keep a running list of things you need to do to fix this.
2. For income you did earn but didn’t report on your return, check for deductions.
So let’s say you were an Uber driver and you made $50,000 gross during the year driving for Uber but you forgot to include your Uber income on your tax return.
So nine to 15 months after you file your return, the IRS sends you a CP2000 indicating that Uber issued you a 1099 showing $50,000 and the IRS is proposing an assessment of taxes, penalties, and interest on you assuming that you should have reported an additional $50,000 of income on your tax return.
And in this instance, the IRS is correct that you didn’t report that $50,000 of Uber income as gross receipts on your Schedule C. However, you have business deductions you can take against that $50,000; so you shouldn’t be taxed on the full $50,000 — which is what the IRS is proposing in the CP2000 — you should only be taxed on your net business income from your Uber driving.
And obviously from that $50,000 gross, you can deduct things like Uber’s cut as well as the vehicle expenses you incurred while earning income driving for Uber using either the standard mileage method or the actual expenses method (not going to get into that here). And those expenses might be $30,000 — I’m just making up a figure, by the way — so your net business income would only be $20,000.
So even though the IRS is right you didn’t report that $50,000 as gross receipts on Schedule C like you should’ve, the IRS doesn’t know your expenses, and they’re not going to estimate expenses for you; it’s on you to inform the IRS about these expenses. If you would have reported the $50,000 of gross Uber income on your Schedule C, you would have reported these expenses to the IRS on all the expense lines on Schedule C, but because you didn’t, you’ll have to inform the IRS of them in your response to the CP2000.
On this point, may even want to prepare a dummy Schedule C to attach to your response saying, “Hey, IRS, this is what my Schedule C should have looked like had I filed it correctly.”
3. Calculate how much taxes you actually owe.
So now that you’ve gone through the previous steps, I would actually recommend that you prepare a tax return showing what your tax liability should actually be if you include all the income you didn’t report correctly on your actual tax return, including deductions.
If you still have access to your tax software, you can try to do it that way or if you’ve hired a professionals like us at Choice Tax Relief to respond to the CP2000 on your behalf, we will do that for you.
Because at the end of the day, you want to know what you actually owe; don’t trust the IRS to calculate your liability for you.
Now, if you really want to get fancy, you would probably want to calculate the penalties and interest as well to check the IRS’ math on that — and that’s something we would do for you at Choice Tax Relief — but that may be a bit complicated if you don’t have the tools to do that.
4. Determine if you’re still subject to the substantial understatement penalty.
That said, there is one penalty that you should probably do the math on, and that’s the accuracy-related penalty for substantial understatement of tax.
The IRS assesses this penalty if you understate your tax liability on your tax return and this understatement is more than the larger of these two figures:
- 10% of your correct tax liability
So let’s go back to the Uber example. IRS says that you didn’t report $50,000 of self-employment income, and it calculated what it believes your tax to be on $50,000 of self-employment income in the proposed assessment.
The actual math is more complicated than this, but assuming your marginal regular income tax rate on all this income is 24%, the IRS would say you owe an additional $12,000 in regular income tax on this income.
And you’d also be subject to self-employment tax at a rate of 15.3% on this income assuming that you haven’t maxed out your Social Security income limit through other income you earned.
(And yes, tax nerds, I know there’s a a 92.35% multiplier in here as well, but let’s just keep things simple for the sake of example.)
So that means that the IRS would also propose an assessment of $7,650 of self-employment tax on this $50,000 as well, but let’s round up to $8,000 just for sake of example.
So combining the $12,000 in regular income tax and $8,000 of self-employment tax, then in the IRS’ mind, the amount of your understatement of tax liability on your tax return is $20,000.
Now what you have to do is add this figure to the amount of tax liability you actually reported on your return — let’s say that was $10,000. So your “correct” tax liability in the IRS’ mind is $30,000.
So in the IRS’ mind because your $20,000 understatement exceeds $5,000 (which is the greater of $5,000 or 10% of your correct tax liability of $30,000, so the greater of $5,000 or $3,000), it believes that you are subject to the substantial understatement penalty.
And the penalty itself is 20% of the understatement, so in this case 20% of $20,000, which is $4,000.
5. Send your response to the IRS, along with supporting documentation.
At this point, you have an idea of what your game plan is and what you think the additional assessment of tax should be.
So now, you have to explain all this to the IRS because they’re not going to change their mind if you don’t change their mind; they’ve proposed an assessment and have communicated it to you on the CP2000; now you have to step up to the plate and convince them otherwise.
You do this by writing a letter to the IRS and faxing it to the number on the CP2000.
What if you agree with the IRS?
If you agree with the IRS’ proposed assessment in the CP2000 — meaning that 1) you agree that you did not report the income the IRS indicated in the “Explanation of changes” section of the CP2000, 2) you have no deductions or other tax benefits to claim about this income, and 3) you agree with the IRS’ calculation of the tax on this income along with penalties and interest, simply check the box next to “I agree with all changes” and send that back to the IRS.
IRS Notice CP2000 FAQs
Here are some frequently asked questions about IRS Notice CP2000.
Is a CP2000 an audit?
No, a CP2000 is not an audit.
IRS audits typically result in an extensive examination of a taxpayer’s books, records, and other supporting documentation for amounts or positions taken on their tax return.
CP2000 Notices, however, are simply computer-generated notices that inform a taxpayer of discrepancies between their tax return and other tax documents filed with the IRS.
What if you submit an amended return in response to a CP2000?
If you submit an amended return in response to a CP2000, the processing unit that you submitted the amended return to would simply transfer your amended return to the IRS Automated Underreporter Unit, and they would inform you of this using Letter 86C.
Here’s an example Letter 86C the IRS sent our client because they mailed in an amended return in response to a CP2000.