Tax Audit Penalties and Consequences

People sometimes fail to accurately file their tax returns for various reasons. For example, some taxpayers may underreport their cash income, which can lead to tax penalties. For this reason, the IRS picks out tax returns that seem suspicious and proceeds with the audit process. There are many reasons why a tax return can be audited. 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.

Types of Tax Audit Penalties

The IRS processes tax audits to uncover inaccurate tax returns. During the audit process, the IRS will determine if any of the inaccurate tax returns are subject to: (1) additional interests, (2) civil penalty, (3) civil fraud penalty, or (4) criminal penalty. First, "additional interests" apply to taxpayers who file their tax returns late or fail to pay the taxes on time. The interest rate depends on the amount owed and the timing of the underpayment.

Second, "civil penalty" applies to mistakes and errors made in a tax return. If those mistakes or errors result in a substantial discrepancy in your tax return, you may have to pay civil penalty of up to 20 percent of the underpayment. However, if you reasonably make a good faith argument that you relied on a certain substantial authority, you may be able to avoid the penalty.

Third, "civil fraud penalty" refers to penalty for any underpayment of tax that results from a fraudulent activity. If you fail to pay the taxes or underpay the taxes you owe, you will be charged 5 to 25 percent of the unpaid tax each month. In cases of civil fraud, a penalty of up to 75 percent of the underpayment will be added to your outstanding balance. If you fail to pay the taxes after an audit within 21 days, the IRS will charge you additional penalties of 0.5 percent for each month you are late in paying the taxes.

Fourth, an IRS tax audit will result in "criminal penalties" if you are convicted of crimes, such as tax evasion. A criminal penalty is the most severe penalty that a taxpayer can face during the audit process. If you've committed tax evasion, fraud, or any other similar crimes, you can face a substantial amount of civil penalty, additional fines related to the crime, and even jail time.

Your Legal Options and Consequences

So, if you're facing any of the above penalties as the result of the audit, you have two options: either to accept the penalties and interests charged or deny the result of the audit. If you decide to accept the IRS's audit conclusion, then you must pay the amount by the deadline.

If you wish to challenge the result of the audit, you can file a request for an audit reconsideration. Do not pay any taxes, penalties, or interests that you intend to dispute. If you've already paid any of those taxes, penalties, or interests, you need to first request a refund. Then, you need to submit the following documents for an audit reconsideration: statement that explains why you are requesting a reconsideration; a Form 1099; copies of supported documents; and copies of the IRS letters. The IRS will grant the request only if your situation falls within limited qualifying circumstances, such as you didn't receive proper notice, the IRS made an error, or you did not appear for an audit.

Get a Free Case Review by a Tax Attorney

There are several reasons why a person may receive tax audit penalties. Even a slight error may lead to additional charges to your tax return. However, special circumstances may allow the IRS to reconsider your audit or change the result. If the IRS audits your tax return and applies penalties, consider contacting an experienced tax attorney in your area for a free case review and discover ways to ease your burden.

Next Steps

Contact a qualified tax attorney to help you navigate your federal and/or state tax issues.

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