IRS Tax Audit Penalties & What You Should Know
If you have been summoned for an audit by the IRS, you should know that the odds of escaping without owing additional taxes are slim. In general, the IRS does not spend resources on conducting tax audits unless there’s a good chance for significant revenue to be gained.
What you may not be aware of is that, if you owe more, along with extra taxes, you will likely be assessed tax penalties of some type. The amount and severity of the tax penalties are directly related to the type of deficiency the audit uncovered. But you also have the opportunity to soften the blow or perhaps even qualify for a penalty abatement.
Accuracy Related Tax Penalties
If an IRS audit finds that you filed a substantially inaccurate return, you could be facing accuracy related tax penalties of 20% of the amount you underpaid. In extreme cases, the penalty charged could be doubled to a whopping 40% of your total tax underpayment. The following list indicates the types of accuracy related tax penalties that may result from an IRS tax audit. (About Money)
- Negligence or Disregard of Regulations. Failure to make a reasonable attempt to adhere to Federal tax code rules, such as failing to file a tax return at all
- Disregarding IRS Rules or Regulations. Positions taken on tax returns that are substantively inconsistent with IRS regulations
- Substantially Understating Your Taxes. Understating your income by $5,000 or 10%, whichever is greater.
- Substantially Misstating the Value of Property. Overvaluing of donated property or undervaluing of depreciating property by 200% carries a 20% penalty. Overvaluing donated property or undervaluing depreciating property by 400% carries a 40% penalty
- Substantially Overstating Pension Liabilities. Overstatement of pension liabilities by at least 200% carries a 20% penalty; overstatement of pension liabilities by 400% carries a 40% penalty. No penalty will be applied if the overstatement is $1,000 or less
- Substantially Understating a Gift or Estate. Erroneously stating the value of property claimed on a gift tax or estate tax return at 65% or less of its actual market value carries a 20% penalty. Erroneously stating the value of property claimed on a gift tax or estate tax return at 40% or less of its actual market value carries a 40% penalty. No penalty will result if the understatement results in a tax underpayment of $5,000 or less.
- Understatements Related to Reportable Transactions. There’s a 20% penalty for understating tax liabilities due to a tax shelter or tax avoidance transaction that are disclosed. Inadequately disclosed tax shelters or tax avoidance shelters carry a 30% penalty.
Penalties for Failure to File Returns and Pay Taxes
If you are late in filing your tax return or paying your taxes, the penalty is 5% of the unpaid tax, charged each month, up to a maximum of 25%. A minimum penalty of $135 can be charged for returns filed more than 60 days late. Filing your return on time but paying late carries a lighter penalty of 0.5% of the tax you owe each month up to 25%. If you are charged for both tax penalties for the same month, the penalty for failure to file is reduced to 4.5%. (IRS.gov)
If you fail to pay up on taxes owed after an audit, the IRS will assess a penalty of 0.5% for each month the tax is not paid. The clock starts ticking 21 days after the IRS issues the notice. If you pay the amount owed in full within 21 days, you will not be charged an additional penalty.
To add insult to injury, if an audit results in accuracy related penalties, fraudulent failure to file a tax return or civil fraud, the IRS adds interest of 3% annually to the amount of your penalty. If the penalty is $100,000 or less, you have 21 days to pay in full before interest is added. If the penalty is more than $100,000, you only have 10 days to pay up before the IRS begins adding interest.
Civil Fraud Penalty
If an IRS audit results in a charge of civil fraud, you won’t wind up in jail. But the IRS slaps a hefty 75% penalty on any tax underpayment that resulted from fraudulent activity.
There is one sliver of a silver lining to this financially dark cloud — accuracy related penalties cannot be applied to taxes owed as a result of civil fraud. In other words, you can’t be penalized on top of a penalty.
Fraudulent Failure to File a Tax Return
If you mistakenly believe that you were not obliged to file a tax return and the IRS catches up with you through an audit, you’ll be hit with tax penalties for failure to file and failure to pay, but you won’t be charged with fraudulent failure to file a tax return.
Instead, fraudulent failure to file a tax return refers to a deliberate failure to file a return and can be either a civil or misdemeanor criminal offense, although civil charges are much more common. If criminal charges are filed, you could be sentenced to up to a year in jail plus $25,000 in fines for each year that you fail to file. The statute of limitations for criminal charges is six years; there is no statute of limitation for civil charges.
Willful Failure to Pay Estimated Taxes or Keep Records
Willful failure to pay estimated taxes or maintain tax records is considered to be a misdemeanor by the IRS. Just as with fraudulent failure to file a tax return, civil rather than criminal penalties are applied most often for this type of infraction. If the IRS brings criminal charges against you, as the result of an audit or criminal investigation, you could face up to a year in jail and $25,000 in fines for each year for which you are charged.
Filing a Fraudulent Return
Many tax protesters, including actor Wesley Snipes and singer Lauryn Hill, have found themselves on the wrong side of the law because they filed frivolous returns based on claims that income taxes are unconstitutional. Filing a fraudulent tax return is considered a felony, but less serious than tax evasion. If you are convicted of filing a fraudulent return as a result of an audit or as a result of IRS investigation, you could face up to 3 years in prison and up to $100,000 in fines. (IRS.gov)
Tax Evasion
Tax evasion has snared some of the most notorious figures in history, including Chicago crime syndicate boss Al Capone. The IRS defines tax evasion as the willful concealment or misrepresentation of financial resources and assets to avoid paying taxes. If an IRS audit or criminal investigation results in a tax evasion conviction, you could be facing up to 5 years in prison and up to $100,000 in fines.
Audit Reconsideration
If worse comes to worse and you are nailed with more taxes and penalties as the result of an audit, but you disagree with the result, you can request an audit reconsideration. You must request it before you pay any taxes, penalties, or interest that you intend to dispute, not after. If you have already paid the taxes, penalty, and interest, you must request a refund. Submit the following documentation to the same office that conducted your audit. (Journal of Accountancy)
- Statement explaining your reasons for requesting an audit reconsideration
- Form 1099, cancelled checks, bank statements, and similar new documentation
- Copies of previously supplied materials
- Copies of correspondence from the IRS
The IRS is not obligated to grant your request. But if you can demonstrate any of the following circumstances, your request for audit reconsideration should be approved.
- You did not appear for the audit
- You moved and did not receive proper notice for the audit
- You submitted documentation that the IRS refused to consider that would reduce or eliminate the taxes, penalties, or interest you owe
- You have new documentation to support your case
- You file a return that shows the correct tax to replace a return created by the IRS because you previously failed to file a return
- The IRS committed math or processing errors in calculating the tax you owe
The IRS should respond to your request for an audit reconsideration within 30 days, although the wait could be longer. Bear in mind that tax penalties and interest continue to accumulate during that time. If you are suffering financial hardship due to delays in processing your audit return, you can ask for your request to be expedited.
Offer in Compromise and Penalty Abatement
If your request for audit reconsideration is denied, you may still be able to ease your burden. If you cannot pay the full amount of tax that you owe, you may request an Offer in Compromise, which settles your tax obligation for a fraction of what you actually owe. Be forewarned that the IRS accepts only a small percentage of Offers in Compromise. Obtaining expert advice from the experts at Optima Tax Relief will improve your odds.
Under certain circumstances you may request a penalty abatement, which results in some or all the penalties you have been charged being waived. The IRS generally approves requests for penalty abatement based on reasonable cause or administrative waivers. To request a penalty abatement, file IRS Form 843 along with copies of any documentation you may have to support your request.