– What Happens if You Fail an IRS Audit –
People sometimes fail to accurately file their tax returns for various reasons, which can lead to tax penalties Once your tax return is being audited, there’s a higher chance of receiving penalties if you fail to give accurate information or follow proper directions.
Read on to learn about the potential tax audit penalties and consequences.
What Are Tax Audit Penalties?
The IRS chooses tax returns for an audit intentionally and randomly. Therefore, being audited does not automatically mean that you have to pay penalties.
However, the IRS will examine your tax return to uncover any existing errors, problems, or outstanding balance of unpaid taxes.
Depending on the deficiency or the amount of unpaid taxes, your tax return can be subject to additional tax interests, civil penalty, civil fraud penalty, or criminal penalty.
The amount and the type of tax audit penalties will depend on the severity of the deficiency found in your tax return.
Why Do Taxpayers Receive Tax Audit Penalties?
There are several different reasons for receiving tax penalties that result from a tax audit. Here’s a list of some of the most common reasons why taxpayers face tax audit penalties:
- Ignoring the IRS rules and regulations: Failure to follow the IRS rules and regulations, such as failing to file your tax return.
- Underreporting Your Taxes: You will face penalties if you underreport your income by $5,000 or by 10 percent of the actual income.
- Misstating the Value of Your Property: Either overvaluing the property or undervaluing depreciating property will result in tax penalties.
- Not Paying Your Taxes by the Deadline: The IRS will charge you with a failure-to-pay penalty, which is normally half of one percent of your unpaid taxes. The amount of failure-to-pay penalty will apply monthly until your taxes are fully paid.
- Understating a Gift or Estate: If you understate the value of a gift or estate by more than $5,000, you will have to pay civil fraud penalties.
- Understating Other Reportable Transactions: When you understate any other tax liabilities, such as inadequately disclosing tax shelters.
What Happens When you Get Audited?
An audit can go one of three ways:
- The IRS finds out you don’t owe them any money, and leaves you alone.
- The IRS finds out you owe them money. You sign an official document, confirming the amount you owe. Then you pay up.
- The IRS finds out you owe them additional tax, and you dispute it. In this case, you’ll want the support and expertise of a tax lawyer, an enrolled agent, or a CPA. Depending on your argument, the IRS will either reduce the amount you owe, make you pay the full amount, or throw out the charges altogether.
How to Respond to Various Types of Audits
How to Respond to a Mail Audit
The IRS does most audits by mail. Mail audits (also called correspondence audits) typically focus on a few items on your return. The IRS wants you to provide proof of those items.
Often, this is income you may have left off your return or income that doesn’t match other information the IRS has about you.
The IRS will give you a deadline (often 30 days) to respond with documentation, or proof, of your position on your return. You can ignore it, or you can respond.
Here’s what happens if you ignore the notice:
- The IRS will make changes to your return (like adding income or removing deductions and/or credits).
- The IRS will propose taxes and possibly penalties, and you’ll get a “90-day letter” (also known as a statutory notice of deficiency).
- You’ll have 90 days to file a petition with the U.S. Tax Court.
- If you still don’t do anything, the IRS will end the audit and start collecting the taxes you owe. You’ll also waive your appeal rights within the IRS.
Here’s what you should do:
- Gather and organize all the documents that the IRS is asking for, plus a clear summary, and send them to the IRS by the due date.
- If you’re missing documents or you want help responding, a tax pro can organize your response and contact the IRS for you.
How to Respond to an Office Audit
Office audits are usually more extensive than mail audits because office audits involve more parts of your tax return.
The stakes are also higher. The IRS agent will often want a face-to-face meeting, so most people in this situation get a tax pro to represent them and deal with the IRS.
Again, you can ignore this issue, or respond.
Here’s what happens if you ignore an office audit:
You’re not doing yourself any favors if you don’t show up for an appointment with the IRS. You may have avoided the meeting, but you’ll pay for it later in taxes, penalties, and interest.
The IRS will change your return, send a 90-day letter, and eventually start collecting on your tax bill. You’ll also waive your appeal rights within the IRS.
(You can’t ignore IRS collection, either. The IRS can collect your tax bill with federal tax liens, wage garnishments, and levies.)
Here’s what you should do:
It’s a good idea to engage a qualified tax pro well ahead of your audit appointment with the IRS. Your tax pro can represent you, meaning he or she can deal with the IRS for you.
A tax pro will also tell you what to provide and how to present it. You may not even have to attend the appointment.
Whether it’s you and/or your tax pro at the meeting, you should give clear, complete, and truthful answers to the auditor’s questions.
How to Respond to a Field Audit
Field audits are the most serious type of audit. They usually target high-wealth individuals and/or businesses. And they’re less like an audit of your tax return and more like an audit of you.
In other words, the IRS revenue agent is going to look into your life to try to see if you reported everything you should have on your return. For example, the agent will likely look at your bank statements and ask you to explain certain deposits or discrepancies.
In a field audit, the IRS revenue agent will visit your business and/or home. But a good representative can often deal with the IRS directly and limit your contact with the IRS.
IRS revenue agents don’t easily give up on locating and contacting taxpayers for field audits. So ignoring a field audit isn’t really practical, but here’s what would happen if you did.
If you ignore a field audit:
The revenue agent is going to change everything the IRS was questioning on your return. The IRS will basically reconstruct your income situation based on the information it has. That will mean more taxable income, and more taxes that the IRS will collect.
Once the revenue agent has changed your return, the IRS will send a 90-day letter and then start collecting the tax. Again, you’ll waive your appeal rights – and you aren’t likely to get them back.
Here’s what you should do:
Field audits can be complex and often involve interpreting tax law and procedure. The average taxpayer requires a tax pro to get the best result in the least amount of time. Your tax pro can:
- Represent you with a power of attorney
- Guide you through the audit
- Meet with the IRS
- Handle contacts with the IRS revenue agent
Understanding how audits work is critical to getting the best outcome – including minimizing penalties — and reducing the time it takes the IRS to audit you.
For any audit, it’s best to be proactive and follow these basic principles
- Use your right to representation, especially in office and field audits. Tax professionals know your rights and can protect them.
- Follow your tax pro’s advice. He or she should handle most or all contacts with the IRS.
- Prepare complete, clear, truthful responses by the deadline.
- Keep the IRS in loop. You or your representative should let the IRS know if you can’t keep an appointment or need to extend a deadline.
What Information does the IRS Need?
The IRS will tell you what records they want to see. The records are documents that support claims on your tax returns. Here are just some of the records the IRS might ask you for:
- Canceled checks
- Legal papers
- Loan agreements
- Employment documents
Make sure you organize your records by year and type of income or expense. Include additional information detailing the transactions. If you have any further questions about the records, contact your auditor.
What is the Taxpayer Bill of Rights?
In 2014, the IRS announced the Taxpayer Bill of Rights, a document meant to help taxpayers understand the complexity of taxes. There are 10 basic rights that apply to general taxpayers as well as those being audited:
- The Right to Be Informed
- The Right to Quality Service
- Right to Pay No More than the Correct Amount of Tax
- The Right to Challenge the IRS’s Position and Be Heard
- The Right to Appeal an IRS Decision in an Independent Forum
- A Right to Finality
- The Right to Privacy
- The Right to Confidentiality
- A Right to Retain Representation
- The Right to a Fair and Just Tax System
Before you get stressed about what the IRS can and can’t do during an audit, consult the Taxpayer Bill of Rights.
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