What to Do if the IRS Adjusts Your Self-Employment Income

Quick overview

If the IRS adjusts your self‑employment income you’ll usually receive a notice explaining the proposed change (commonly a CP2000 or similar correspondence). Don’t ignore it. The notice will tell you how much the IRS thinks you underreported or overreported, how they calculated changes, and how long you have to respond (often 30 days). Acting quickly preserves your rights to challenge, provide documentation, or correct your return.

(For how notices work generally, see the IRS guide “Responding to a Notice or Bill” (IRS.gov).)

Step‑by‑step: Immediate actions (first 7–14 days)

1. Read the notice carefully

• Note the tax year, the proposed change, and the deadline to respond. Most IRS notices include a response deadline (commonly 30 days) and instructions for where to send supporting documents.
• Identify whether the IRS is changing income, deductions, credits, or a mix.

1. Don’t panic — gather records

• Pull the tax return for the year in question and the supporting schedules you filed (for self‑employed filers this usually includes Schedule C and Schedule SE). If you’re unsure what you filed, you can request a transcript from the IRS (IRS Get Transcript service).
• Collect bank statements, deposit records, invoices, 1099s, contracts, payment apps (e.g., PayPal records), mileage logs, receipts, and bookkeeping exports for that tax year.
• If the IRS matched third‑party reporting (like a 1099‑NEC) to their records, get the original 1099(s) you received and compare line‑by‑line.

1. Compare IRS figures to your books

• Make a clear reconciliation table: IRS amount vs. your reported amount vs. variance and a short explanation for each item.
• Often discrepancies come from missing 1099s, misclassified personal vs. business receipts, or timing differences (payments received in one year but reported in another).

1. Decide: accept, correct, or dispute

• Accept: If you made an error and agree with the IRS numbers, follow the notice instructions to pay the balance, or request an installment agreement if needed.
• Correct: If you made a reporting mistake (e.g., omitted income or wrong expenses), you can file an amended return (Form 1040‑X) and include corrected schedules (like Schedule C and Schedule SE). Amending can reduce penalties if it reduces the balance due; be sure to follow the IRS guidance on when to file an amendment versus responding directly to the notice.
• Dispute: If the IRS is wrong, respond in writing with documentation that supports your originally filed figures. A well‑organized response reduces the chance the IRS will uphold the adjustment.

How to respond in writing (what to include)

• A cover letter that references the notice number (e.g., CP2000), tax year, and your identifying information (name, SSN, address, phone). Keep tone factual and concise.
• A reconciliation worksheet that lists each disputed item, your reported amount, the IRS amount, and the source documents you’re providing.
• Copies (never originals) of substantiating documents: invoices, canceled checks, bank statements, 1099s, contracts, receipts, mileage logs, and your ledger or accounting exports.
• If you’re amending your return, include Form 1040‑X and the corrected schedules (e.g., Schedule C and Schedule SE). If you file an amended return, note it in your letter and explain why the amendment was necessary.

In my practice, packages that include a short, numbered reconciliation and a clearly labeled stack of exhibits reduce reviewer confusion and speed resolution.

Typical notices and timelines

• CP2000 (proposed changes based on third‑party reporting): usually gives about 30 days to respond. See the IRS CP2000 page for details (irs.gov/individuals/cp2000-notice).
• Correspondence exam (document request): may have shorter response times and asks for original or copies of specific documents.

The IRS uses automated data matching to compare Forms 1099, W‑2, and other information to filed returns. If the match doesn’t reconcile, you’ll get correspondence (IRS explains their matching and notice process on their site).

Amending versus responding to the notice

• If the IRS is proposing additional income and you actually omitted income, filing Form 1040‑X to correct your return often resolves the issue and shows good faith (include the tax, interest, and any applicable penalty calculations where possible).
• Sometimes it’s faster to respond to the notice with documentation showing you did report the income (for example, a 1099 dispute where you can show payment was reported elsewhere or recorded differently).
• If you file an amended return after receiving a CP2000 and you still disagree with the IRS calculation, you should include a copy of the amended return with your response and explicitly reference the CP2000 notice.

For details on amending returns, see the IRS guidance on Form 1040‑X (irs.gov/forms‑instructions).

Penalties and interest — what to expect

• Taxes owed because of an adjustment accrue interest from the original due date of the return until paid. The interest rate is set quarterly by the IRS.
• Penalties may apply for negligence or substantial understatement. The common penalties are the failure‑to‑pay penalty and accuracy‑related penalties (IRC §6662). Whether a penalty applies often depends on whether you acted reasonably and in good faith.
• Reasonable cause documentation (e.g., reliance on a tax professional, lost records due to disaster) can reduce or eliminate penalties if convincingly documented.

Cite: IRS Tax Topic on Notices and Bills; IRS penalty guidance (irs.gov).

Options if you can’t pay the additional tax

• Pay the balance in full to stop additional interest and failure‑to‑pay penalties from growing.
• Request an installment agreement online or by mail (short‑term or long‑term) — the IRS offers options depending on amount and financial situation.
• If you qualify, apply for currently not collectible status, or in rare cases, an Offer in Compromise (OIC) if you can’t pay the tax in full and meet strict eligibility. OICs are difficult to obtain and require complete financial disclosure.

If you need help evaluating payment options, a CPA or enrolled agent can run the numbers and negotiate with the IRS on your behalf.

Appeal rights and the IRS appeals process

• If you disagree after the IRS makes a change, you can file a formal protest or use the IRS independent Office of Appeals. The notice you receive will explain appeal rights and deadlines.
• For smaller adjustments, the IRS often has an informal appeals process. For larger or complex adjustments you may need to prepare a formal written protest including legal arguments and evidence.

See the IRS appeals information for procedures and timelines (irs.gov).

Preventing future adjustments — practical controls

• Keep consistent bookkeeping and reconcile bank deposits to income ledgers monthly.
• Track receipts and mileage contemporaneously; use apps or spreadsheets that timestamp entries.
• Request corrected 1099s from payers if they issued an incorrect form. If they refuse, document your communications.
• Separate personal and business accounts and avoid cash commingling.

If you file a Schedule C, review our guide on Schedule C best practices to reduce red flags and improve substantiation: Schedule C (Profit or Loss from Business).

Common scenarios and how to handle them

• Missing 1099s: If you didn’t receive a 1099 that the IRS shows as paid to you, compare your bank deposits and invoicing records. If the payer issued the 1099 incorrectly, ask them to send a corrected form and include your correspondence in your IRS response.
• Payment app reporting (e.g., third‑party network transactions): Be aware of new thresholds and reporting rules — reconcile payment app statements to your income records.
• Disallowed deductions: Provide business purpose, receipts, and logs. If the IRS questions home office or vehicle expenses, include mileage logs, square footage calculations, and contemporaneous receipts.

Example response outline (sample language)

1. Header: Your name, SSN (last 4 digits), address, phone, notice number and tax year.
2. One‑paragraph summary: “I received Notice CP2000 dated [date]. I dispute the proposed increase to income because [brief reason].”
3. Reconciliation table and list of exhibits (Exhibit A: bank deposits; Exhibit B: invoices; Exhibit C: 1099 copies, etc.).
4. Closing: Request to adjust the proposed changes consistent with the attached documents and a phone number for contact.

When to hire help

Hire a tax professional (CPA, EA, or tax attorney) if any of the following apply:

• The proposed adjustment is large (> $5,000–10,000) or triggers multiple years.
• You’re facing potential accuracy‑related penalties.
• The IRS requests a formal audit or you receive a correspondence exam.
• You’re unsure how to substantiate your deductions or income.

In my 15+ years working with self‑employed clients I’ve found timely, organized responses reduce the likelihood of penalties and shorten resolution times.

Useful resources and internal links

• IRS: Responding to a Notice or Bill — https://www.irs.gov/individuals/responding-to-a-notice-or-bill
• IRS: CP2000 Notice information — https://www.irs.gov/individuals/cp2000-notice
• FinHelp guide: CP2000 Notice — https://finhelp.io/glossary/cp2000-notice/
• FinHelp guide: Schedule C (Profit or Loss from Business) — https://finhelp.io/glossary/schedule-c-profit-or-loss-from-business/

Final checklist before you mail or upload your response

• Include your name, taxpayer ID, tax year, and notice number on every page.
• Mark each exhibit clearly and reference exhibits in your reconciliation.
• Send copies, not originals; keep a complete copy of everything you send.
• Use certified mail or another trackable delivery method if mailing documents.
• If you hire a tax pro, include a signed Power of Attorney (Form 2848) if you want them to speak with the IRS on your behalf.

Disclaimer

This article is educational and does not replace personalized tax advice. Tax law changes and individual circumstances vary; consult a qualified CPA, enrolled agent, or tax attorney for advice tailored to your situation. Author holds CPA and CFP® credentials and has helped hundreds of self‑employed taxpayers manage IRS adjustments.