Penalties and Payment Options When You Fail a Tax Audit
During a tax audit, the Internal Revenue Service or state tax agency asks you to back up the information reported on your tax return. If you cannot substantiate your claims, the auditor can disallow the information on your return, which can lead to a tax bill and audit penalties.
Failing an audit is emotionally stressful but can also be financially devastating. But don’t worry; the tax attorneys at Wiggam Law can help you through it. We leverage our experience with the IRS to help our clients navigate audits, dispute penalties, and deal with tax liabilities after an audit. Call us at (404) 233-9800 or request a consultation today!
What Happens if You Fail an Audit?
Failing an audit means that the IRS auditor makes changes to your tax return. That may include adding income, reducing deductions, or taking away credits. Generally, this leads to a tax liability and audit penalties, but in some cases, auditors can make changes that decrease your tax liability. Read on to learn more about the potential consequences of failing an audit.
Audit Penalties
The auditor may assess the following penalties. Individuals are most likely to face the accuracy-related penalty, while businesses can face a range of different penalties.
- Accuracy-related penalty — 20% of the understated tax if you were negligent about following the tax code or if you substantially understated your income by the greater of $5,000 or 10%.
- Substantial valuation misstatement penalty — 40% of the underreported tax if you misstate the value of property by 150% or more. For instance, this may apply if you overinflate the value of a personal asset that you convert to a business asset.
- Substantial overstatement of pension liabilities penalty — 20% penalty for companies that overstate pension liabilities by 200% or more and a 40% penalty if you overstate pension liability by 400% or more. There is no penalty if the misstatement reduced your tax liability by less than $1,000.
Future Loss of Credits
If you claimed a credit you weren’t allowed to claim, the auditor could assess a 20% penalty. Additionally, you may be banned from claiming the credits in the future.
For instance, if the auditor believes that you negligently claimed the Earned Income Tax Credit (EITC), you will be banned from claiming it for two years. If fraud is suspected, you can be banned from claiming the EITC, the Child Tax Credit, the American Opportunity Tax Credit, and the Credit for Other Dependents for ten years.
Fraud Penalties
In cases of fraud, the auditor can assess a penalty of 75% of the underreported tax. For instance, say that the auditor makes changes to your tax return that increase your tax bill by $20,000, and the auditor believes that you committed fraud while filing your original return. In this case, the penalty would be $15,000. If you fraudulently understated $100,000 in taxes, the penalty would be $75,000.
Late Payment or Late Filing Penalties
These penalties don’t just apply if you’ve been audited. They apply any time that you file or pay late. However, they can come up during an audit if the auditor realizes you have not paid or filed late. The failure-to-file penalty is 5% of the tax due, and it applies monthly from the later of the due date or the filing date until you pay the tax. The failure-to-pay penalty is 0.5% of the unpaid tax per month, but it can increase to 1%.
Interest
If the auditor assesses tax against you, interest will be back-dated to the later of the due date or the filing deadline. For instance, say that the IRS audits a tax return that was due and filed on April 15, 2021, and they discovered that you owe an additional $10,000 in taxes. Then, interest will be backdated to April 15, 2021, and it will continue to accrue until you pay the tax liability in full.
Interest will also accrue on the penalties that are assessed on your account. Note the IRS will almost never remove interest, but if you get penalties removed, the interest associated with those penalties will also be removed.
Additional Scrutiny on Past Returns
Failing an audit doesn’t just affect the tax return that was audited. If the auditor only found small mistakes, they will likely assess a tax liability and move on. However, if they found significant errors in your returns, they may decide to audit tax returns from past periods.
Normally, the IRS only has three years to audit a tax return, but if they believe that fraud was involved, they can go back an unlimited amount of time. For instance, if they think that fraud was involved in the return they audited, they may look at several years of returns to see if you committed fraud during other tax periods.
How to Pay Taxes Due to Failing an Audit
If you weren’t expecting a tax bill, you might be wondering how you’re going to afford it. Luckily, the IRS has several different payment options for taxpayers who cannot afford to pay their tax liabilities in full. Here are the main options for individuals:
- Payment plans — Make monthly payments on your tax debt. The minimum payment is $25, and you generally need to pay off the bill within six years.
- Offer in compromise — Prove that you can only pay a portion of the tax debt and settle for less than you owe. If you have assets, you may need to sell them.
- Currently not collectible — Establish that you truly cannot afford to pay the tax liability, and the IRS will mark your account as uncollectible and stop collection actions. If your situation improves, you will need to pay.
There are also options like a partial payment installment agreement which is a hybrid between a settlement and a payment plan. Businesses can generally only set up payment plans for less than $25,000 and over 24 months or less. If your business is no longer operating, you may be able to apply for a longer payment plan on a higher debt amount, and you may also be able to apply for an offer in compromise.
What to Do if You Fail an Audit
If you fail an audit, the next steps you should take vary based on the situation. Here are some tips to consider:
- Review the audit determination letter closely and ensure you understand why you failed the audit.
- If you agree with the changes, pay the tax liability or contact the IRS to make arrangements on your tax bill.
- If you disagree with the changes, contact a tax attorney to help you dispute or appeal. Make sure to reach out for help ASAP.
- Request penalty abatement. The IRS may waive penalties if it’s your first offense or you had reasonable cause.
For guidance on the best steps in your unique situation, contact the experienced attorneys at Wiggam Law for help today.
What if You Disagree With the Audit Results
What if you felt confident that your tax return was correct, but then an IRS auditor makes changes to it? You don’t have to automatically accept the changes. The IRS allows you to dispute or appeal audit assessments. Take a look at your options below.
Managerial Review
First, start by requesting a managerial review. You can explain your side of the story to the auditor’s supervisor. Then, they can make changes as they see fit. If they want to uphold the auditor’s original decision, they may be able to explain the tax code that supports their position to you.
Alternative Dispute Resolution
Also known as mediation, alternative dispute resolution is when you meet with the auditor and an impartial third party. This allows everyone to explain their point of view to a neutral third party. Then, they can help you come to an agreement.
Appeals
Once you receive the official audit determination, you can appeal. The notice should outline your rights to appeal. The most important thing to remember is that the appeals process has strict deadlines. You may lose your chance to appeal if you don’t meet the deadlines. However, in some cases, you can pay the tax under protest and then appeal through the court system.
Help! My Spouse Caused Me to Fail an Audit
What happens if the IRS audits a jointly filed return and all of the issues are related to your spouse? This is a very tricky situation on a marital level, but it’s also legally complicated.
This may happen if your spouse was underreporting income, overstating deductions, or claiming credits they were ineligible for. In most cases, you are responsible for the taxes and penalties on a jointly filed return, even if you failed the audit due to your spouse. When you sign and file a joint tax return with your spouse, you take on joint liabilities. That means that you are responsible for the full bill, whether it is related to your income or your spouse’s.
However, you may be able to get around this rule if the conditions are right. The IRS offers innocent spouse relief for people facing a tax liability due to their spouse’s actions. There are a few different programs under the innocent spouse umbrella, but generally, you must prove that you didn’t know about the understatement of tax and had no reason to know about it. If you know about the tax, you may be able to escape liability if you were coerced or forced into signing the tax return.
Tax Preparer Mistakes Uncovered During an Audit
What if the auditor finds mistakes that were due to your tax preparer? This can be extremely frustrating, especially if you gave your tax preparer the right information and they filed your tax return incorrectly. But unfortunately, you are responsible for the information on your tax return.
When your tax preparer files your return, they should give you a copy, and you should examine it thoroughly. This is easier said than done, and if you don’t know how to read a tax return, you are certainly not alone. Most people don’t know how to interpret these forms.
Nevertheless, you will be liable for the tax due plus any penalties. Generally, you cannot get the penalties removed by arguing that it was your tax preparer’s fault. Tax preparer mistakes are not considered to be reasonable cause which is one of the main strategies people use to get IRS penalties waived.
That said, you may be able to take your preparer to small claims court and hold them financially liable for your losses, or you could engage a malpractice attorney. Often, you won’t even have to go this far. If a reputable tax preparer knows their mistakes cost you money, they may be willing to cover the fees.
Can You Go to Jail for Failing an Audit?
Typically, no, but if the auditor discovers criminal tax fraud, you can face jail time. However, tax fraud doesn’t necessarily lead to criminal charges. In most cases, auditors only assess civil fraud penalties. As stated above, civil penalties are usually 75% of the underpaid tax.
Criminal tax fraud or evasion charges can be up to $100,000 for individuals and up to $500,000 for corporations. You can also face up to five years in prison.
Get Audit Help Now
Are you facing an audit and worried about the outcome? Do you need help responding to a 4564 document request? Have you already incurred penalties due to failing an audit? Do you want to dispute the auditor’s findings? Regardless of where you are in the audit process, we can help you.
The tax attorneys at Wiggam Law have extensive experience helping clients navigate audits, appeal audit results, and apply for penalty relief. We can also help with innocent spouse relief, fraud charges, and any other issues that come up during an audit.
Audits can be extremely stressful, but we’re here to help. Let’s discuss your tax issues today and customize the best solution for your situation. To schedule a consultation, call us at (404) 233-9800 or request a consultation today.