What Happens If You’re Audited and Found Guilty of Tax Errors: Tax Audit Penalties Explained
If an IRS auditor finds mistakes and you “fail” the audit, you may face significant penalties. IRS audit penalties vary based on the nature of the error, but depending on the situation, you may be able to request abatement or appeal the audit’s findings.
This post outlines what happens if you’re audited and found guilty. If you need assistance now, we offer audit representation, and we’re ready to help you. Whether you’ve just received an initial audit notice or have already incurred penalties, East Coast Tax Consulting can offer immediate help.
Key Takeaways
- You may be guilty in a tax audit if you filed an incomplete tax return, such as underreporting your income.
- The IRS will charge tax audit penalties based on the type of mistakes they find, which could amount to 20% of what you already owe.
- Some penalties, such as for fraud, can reach 75%.
- Though rare, it is possible to face criminal penalties for tax audit findings.
- Working with a CPA and tax expert can reduce the risk of costly mistakes while also aiding through the audit process.
Why IRS Audits Lead to Penalties
The purpose of an audit is to verify the accuracy of tax filings. If an IRS auditor discovers errors, they will correct them, require you to pay the unreported tax, and assess audit penalties. The IRS uses audit penalties to penalize taxpayers for filing incorrect returns, but the penalties also ostensibly serve a broader purpose in that they help to deter fraud and improve compliance with the tax code.
Audit penalties range from modest penalties to substantial tax fraud penalties, based on the type of error and the reason behind it.
Common reasons for audit penalties include:
- Mistakes and oversights: The tax code is complicated, and it’s easy to make a small error or oversight. Auditors understand that mistakes happen and generally don’t apply significant penalties in these situations.
- Reporting personal expenses as business deductions: This may include claiming your personal vehicle use as a business deduction, for example.
- Unsubstantiated deductions: If you can’t substantiate personal or business deductions during an audit, the auditor may disallow them.
- Inaccurate valuations: Auditors may require you to substantiate the cost of capital assets depreciated by your business, the basis of assets sold, f or the value of assets donated to charity.
- Unreported income: Failure to report all of your income will also lead to penalties, but again, audit penalty amounts vary based on how much income wasn’t reported and your reasons for not reporting it.
- Negligence: You did not follow the tax code, and you also did not make a good-faith effort to learn about it or file an accurate return.
- Fraud: You willfully submitted false information on your return, often in an attempt to evade the assessment or payment of the tax.
Generally, these types of audit errors lead to civil penalties, but in cases where the IRS suspects criminal behavior, they may refer the case to Criminal Investigation, which will investigate the situation and decide whether to pursue legal charges for criminal tax fraud against you.
| IRS Penalties for Tax Audit Findings | |||
|---|---|---|---|
| IRS Audit Finding | Typical Penalty | Penalty Amount | Can It Be Abated? |
| Math errors | Generally no penalty | Not applicable | Not applicable |
| Substantial understatement of tax due, of 10% or $5,000, whichever is greater | Accuracy-related penalty | 20% of the unreported tax | Possibly, if you can show reasonable cause |
| Negligence or disregard of rules | Accuracy-related penalty | 20% of the unreported tax | Possible but difficult |
| Fraudulent information reported on return | Civil fraud penalty | 75% of underpayment | Generally not |
| Criminally fraudulent return | Criminal tax fraud penalties | Up to $250,000 in penalties, up to 5 years imprisonment | No |
Accuracy-Related Audit Penalties
An accuracy-related penalty typically applies when you understate the tax due on your return. For example, you may incur these penalties for not reporting all of your income or taking a credit or deduction that does not apply to your situation.
These penalties are 20% of the unreported tax. For example, if the audit determines you owe an additional $40,000, the penalty would be $8,000.
There are two types of accuracy-related audit penalties:
Negligence or Disregard of the Rules or Regulations
Negligence claims apply when you fail to make a reasonable attempt to follow tax law when preparing your return. That could be due to reckless, careless, or intentional violations of the tax regulations applicable to your situation.
Substantial Understatement of Income Tax Penalty
This form of accuracy-related penalty occurs if you understate the taxes you owe on your return by 10% or $5000, whichever is greater. If you claim a Qualified Business Income (QBI) Deduction, the threshold drops to the greater of 5% or $5000.
For example, say you understate your tax liability by $10,000, but your total tax liability is $120,000. Although the understatement is less than 10% of your tax liability, it’s over $5000, so the accuracy penalty will apply.
In contrast, imagine you understate your liability by $600, but your total liability is $3000. Although the understatement is over 10%, it’s still well under the $5000 threshold, meaning the accuracy penalty for understatement does not apply.
Civil Fraud Penalties vs. Criminal Tax Exposure
In the vast majority of cases, the IRS addresses fraud using civil penalties, but criminal exposure can be a risk. The difference here is significant, with criminal charges potentially leading to jail time and significantly higher fines. Here’s a look at some of the differences between civil and criminal tax fraud.
Civil tax fraud:
- May include willfully filing a return with false information or willfully not filing.
- Penalties of up to 75% of the unreported tax.
- There is no statute of limitations. The IRS may audit fraudulent returns for an unlimited time period after they have been filed, whereas normally the agency can only audit the last three years or six in cases of significant tax understatement.
Criminal tax fraud:
- Also includes willful actions that may be prosecuted under several different tax code statutes.
- Penalties include up to five years imprisonment and up to $250,000 in fines ($500,000 for corporations) for each count.
- The statute of limitations is six years from the last affirmative action.
Signs the IRS May Escalate an Audit Into a Criminal Investigation
The IRS may escalate an audit into a criminal investigation if there’s evidence of willful fraud, tax evasion, or intentional deception involved. If the IRS believes a simple, negligent mistake occurred, it is unlikely to go further, but again, even with a significant income understatement, the IRS usually assesses civil penalties.
The following are some reasons why a civil IRS case may become a criminal investigation:
- Evidence of falsified statements
- Patterns of concealment
- Fabricated records
- Admissions made by the taxpayer during the interview
- Third-party whistleblower information
If the IRS auditor stops communicating with you suddenly, that may be a potential indication of a shift to a criminal focus. Their line of questioning may also change and become more focused on the intent rather than on numbers. If an agent from Criminal Investigation contacts you, that’s a definite sign that you’re facing potential criminal risk and should reach out to legal counsel.
What to Do If You’re Facing Tax Audit Penalties
If you suspect you may be facing IRS audit penalty amounts for any reason, reach out to a tax professional. They will evaluate what occurred, verify the accuracy of the IRS’s position, and help you understand your options and the best path forward.
Here’s what you need to consider.
Consequences of Audit Penalties
If an auditor assesses penalties due to incorrect information on your return, that may:
- Lead to additional scrutiny on past returns.
- Prevent you from claiming certain tax credits. If you claimed credits you did not qualify for, the IRS could prevent you from claiming such credits, even if you do qualify, in the future.
- Create an assessment that you can’t afford to pay, which may lead to collection actions if you don’t resolve the balance due.
How to Respond to Audit Penalties
The response options vary based on how long it’s been since the auditor issued their results, but you may be able to:
- Appeal the audit results. You typically have 30 days from the date you receive the notice to appeal.
- Ask for a reconsideration. If the taxes have been assessed but not paid, this may be an option.
- Request penalty abatement. The IRS may reduce penalties if you show reasonable cause.
- Pay in full or set up payments. If you agree with the additional tax and penalties, the IRS offers numerous payment plans for taxpayers who can’t afford to pay in full.
This is not an exhaustive list. To protect yourself, seek the guidance of a tax professional who can help you understand all the options and potential mitigation strategies.
Payment and Relief Options
If you can’t pay in full, options may include:
- Setting up an IRS installment agreement to make monthly payments
- Requesting an Offer in Compromise to pay less than owed
- Applying for a partial payment installment agreement if you can’t afford a traditional installment agreement
- Asking for currently not collectible (CNC) status if you can’t afford to pay anything, so the IRS stops collection activity on your account
Get Help With Audit Penalties Today
If you’re facing audit penalties or just worried about them, having professional tax guidance makes a substantial difference. Tax law is confusing, but a tax resolution firm like East Coast Tax Consulting Group can help. We will work with you and the IRS to find the most effective solution for your situation.
Contact us now to learn how we can help you.
FAQs
What happens if you are audited and found guilty?
The IRS will notify you of its findings. They will demand payment for what they believe you owe, along with a potential fine of up to 75% in fraud-related cases or, more commonly, up to 20% in accuracy-related errors.
What happens if you fail an IRS audit and a criminal investigation occurs?
The IRS Criminal Investigations will take over the case. They will refer the case to the Department of Justice when they find evidence indicating criminal conduct.
What if I didn’t report all of my income to the IRS by mistake?
You will face penalties if you are audited. If you are not under audit, you can reduce your risk by coming forward voluntarily. A tax expert can let you know if you should amend your return.
Does the IRS charge interest on penalties?
Yes, it does. It starts on the date the payment is due and continues until you pay your balance in full. The IRS adjusts its interest rate quarterly based on the current Fed Rate, and it compounds daily. This is one reason to act quickly to set up a payment arrangement or dispute the findings.