Failed Tax Audit

Key Takeaways:

• Why taxpayers fail audits – They underreport income or don’t have sufficient records to back up deductions or eligibility for credits. 
• Consequences of failing an audit – Failing an IRS tax audit can result in a larger tax liability, plus penalties and interest.
• Common audit penalties – accuracy-related penalties, failure-to-pay penalties, or civil fraud penalties. 
• Payment options – If you can’t pay in full, options include payment plans, offers in compromise, or temporary hardship status.
• Audit representation – Tax attorneys can help you reduce penalties, negotiate settlements, and protect your rights during and after tax audits.

Why You May Fail an Audit

Taxpayers may fail an audit for these reasons:

• Not reporting all income from all the sources that paid you.
• Intentionally underreporting your income.
• Insufficient records to back up the deductions or credits you claimed.
• A lot of errors in your tax return.
• Engaging in fraud.

Taxpayers are audited for all kinds of reasons. Sometimes, they’re selected randomly, while in other cases, the IRS audits their return due to discrepancies with other details – for instance, if the income you report differs from the income reported by an entity that paid you. 

But in all cases, the auditor requires the taxpayer to back up the information on their return. If you can’t do this, you may lose credits or deductions on your return. To “pass” the audit, it’s important to be very thorough with your documentation when the IRS is auditing you. Talk to a tax expert when you need assistance dealing with the IRS.

What Happens If You Fail an IRS Audit?

Failing an audit means mistakes were found on your return that you need to address, such as:

• Underreporting your income, which led to an understatement of tax owed, or
• Claiming tax credits or deductions that you don’t qualify for

In these cases, you will likely face tax penalties since you didn’t pay your full amount owed by the deadline. The IRS will also assess a new tax balance based on its findings, and assess interest on the balance from the date the return was due.

Two Possible Outcomes after a Tax Audit

Once the IRS is done with the audit, it will send you a report summarizing the findings. There are two potential outcomes: proposing changes to your tax return or proposing no changes. 

If you are required to take further action with proposed changes, the IRS will also send you a 30-day letter with a new tax assessment, which could be Letter 525 or Letter 915. You have 30 days to respond to this letter and file an appeal if you don’t agree. If you do agree with the findings, you can accept the proposed changes and make payment arrangements.

Penalties for Failing an IRS Audit

It’s no fun to think about facing IRS penalties after an audit. But if you failed an audit, you need to know what penalties you may be up against and why. Here’s a look at penalties related to failing an IRS audit:

Failure-to-File and Failure-to-Pay Penalties

These are standard penalties the IRS issues when you don’t file your tax return on time (failure to file) or you don’t pay on time (failure to pay). The failure-to-file penalty is 5% of your unpaid tax balance for every month you’re late, up to 25%. The failure-to-pay penalty is 0.5% of your unpaid tax balance per month, up to 25%.

If you get both penalties in the same month, the failure-to-file penalty will be lowered by the amount of the failure-to-pay penalty. The IRS can backdate these penalties to your return due date. Although you filed a return, the failure to file penalty may still apply because you underreported your tax liability, but in some cases, the auditor may decide to only assess the failure to pay penalty.

Accuracy-Related Penalty

A common penalty you’ll get after an audit is the accuracy-related penalty. There are two types:

• Negligence or disregard: This penalty applies if the IRS finds you were negligent of or disregarded tax rules and regulations. The IRS expects taxpayers to make a “reasonable attempt” to follow the tax laws and not to carelessly or recklessly ignore them.
• Substantial understatement of income tax: In this case, the IRS found that you substantially understated your income by 10% of what was required on your tax return or $5,000, whichever is more.

The accuracy-related penalty is 20% of the amount of tax you underpaid because of negligence/disregard or substantial understatement.

For instance, if your original return showed that you owed $15,000 in tax, but you really owed $25,000 in tax, the penalty applies based on the $10,000 that was underreported. Based on a 20% penalty rate, the penalty is $2000.

Civil Fraud Penalty

The IRS may find that you underpaid your taxes because you committed fraud. In this case, they may impose a penalty of 75% of the amount you underpaid due to fraud. Note that if you were negligent or didn’t understand tax laws, it wouldn’t constitute fraud.

Generally, the IRS sticks with civil fraud penalties, but in some cases, you may face criminal fraud charges. If convicted, these charges can lead to hundreds of thousands in penalties as well as imprisonment. Contact us about criminal tax litigation if you’re in this situation. 

Interest Charges

Penalties are added to your existing balance, but don’t forget about interest. Interest accrues on both your unpaid tax balance and your penalties, so it adds up very quickly and can significantly increase your total bill. 

It’s also backdated to the original due date. For instance, say that you’re getting audited for a return that was due two years ago – the interest on the unreported tax and penalties will be backdated two years. 

Options for Tax Relief after Failing an Audit

If you’ve failed an audit, you may be hit with a much larger tax assessment than you planned for. You don’t want to ignore IRS notices and new tax bills, or you risk collection actions like liens and asset seizure.

You can request relief options to get your bill paid off and stay in good standing with the IRS. Let’s look at what you could qualify for:

Installment Agreement

This is the most common option taxpayers go with. An installment agreement (also called a payment plan) allows you to make monthly payments you can afford to get the debt paid off over time. If you owe under $50,000, you can request a payment plan online. If you owe more, you generally need to mail in Form 9465, call the IRS, or work with a tax professional.

Offer in Compromise

The IRS may approve requests for an offer in compromise if it’s clear that your finances don’t allow you to pay the full amount you owe, even with a payment plan. An offer in compromise, if approved, will allow you to settle your debt for less than you owe.

Temporary Collections Pause

If you’re dealing with financial hardship that’s getting in the way of your ability to pay, you can request currently not collectible (CNC) status. This is a temporary pause on collections until your financial situation improves.

File an Appeal

If you don’t agree with the outcome of the audit per the report, you have the right to file an appeal to get the IRS to reconsider. Be ready to provide evidence that supports your claims. Working with a legal expert at this stage will help you strengthen your case.

Penalty Abatement

If you can show reasonable cause, such as going through a natural disaster or experiencing the death of a family member, you may qualify for penalty abatement. The IRS could agree to reduce or waive penalties on your account. The other way to qualify is with first-time penalty abatement, which requires that you complied with tax law for the last three years and didn’t receive any penalties in that time, though not all penalties can be abated in this way.

Tips to Avoid Failed Audits

What can you do to avoid failing an IRS audit? Being proactive is key, but there are specific steps you can take to minimize your risks:

• Keep organized, detailed records throughout the year to track income and expenses.
• Review tax requirements so you don’t miss any important rules and regulations that apply to you.
• Ensure accuracy when reporting on your tax return.
• Be sure not to miss any income you received.
• Ask a professional for help if you have complex tax returns.

Remember to be diligent throughout the year so you’re not scrambling when tax season comes around. If you’re having trouble affording your tax bill, be honest with the IRS instead of trying to hide anything. Have a tax resolution professional speak to the IRS on your behalf is always a good idea. They can help protect your interests and fight to get the best possible outcome.

FAQs Related to Failed Tax Audits

What is the Penalty for failing an IRS audit?

You could face a few different types of penalties if you fail an audit, including the failure-to-file or failure-to-pay penalties, the accuracy-related penalty, or the civil fraud penalty.

Can I Go to Jail for Failing a Tax Audit?

Most taxpayers won’t go to jail for making mistakes on their tax returns, even if they’re audited. The only time you would face jail time is if the IRS charges you with tax fraud or tax evasion, which could be potential outcomes of a failed tax audit. 

Tax fraud could apply if you filed a return with intentionally false information, and tax evasion applies in cases where taxpayers deliberately try to evade paying tax by not filing or filing a false return. To be convicted of tax fraud, you must have acted willfully.

If I Owe Money After a Failed Audit, How Long Do I Have to Pay?

Every situation is unique, but you usually have 30 days from receiving a letter from the IRS about proposed tax return adjustments to make your payment, including your tax balance and any penalties. But normally, you can avoid collection actions if you set up a payment plan during this time period. Pay in full, request payments, or apply for tax relief as quickly as possible to avoid additional penalties.

What If I Disagree with the Audit Findings?

You may not agree with the proposed changes from the IRS post-audit. You have the right to file an appeal to get them to reconsider. Talk to a legal expert about this process to ensure you have all the proof you need to back up your case.

What If I Made an Honest Mistake That Led to a Failed Audit?

Even if you didn’t mean to make a mistake on your tax return, you still have to pay the new assessed amount if it’s correct, plus any penalties and interest. The IRS may apply the accuracy-related penalty even if you didn’t purposely make a mistake.

What If I Failed an Audit Due to Income My Spouse Didn’t Report?

Under the tax code, you are responsible for any information on a jointly filed return. However, in cases where your spouse underreported their income without your knowledge, you may be able to qualify for innocent spouse relief – but the IRS will review the situation very closely to see if you qualify. 

Contact McLaud Law for Tax Audit Help

The good news is that you don’t have to face an IRS tax audit on your own. The legal team at McLaud Law P.C. can help you prepare and represent you in tax audits. We can also help you resolve any issues and apply for tax relief should you need it.

Schedule a free consultation with McLaud Law P.C. today when you have questions about an IRS tax audit.

This communication is Attorney Advertising. It is presented for informational purposes only and does not constitute legal advice. Every legal situation is different, and prior results do not guarantee a similar outcome. This communication does not create an attorney-client relationship between McLaud Law P.C. and the recipient.