IRS Audit Penalties: Will You Receive a Tax Penalty With An Audit?

IRS Audit penalties

An IRS tax audit can be defined as a process by which the IRS examines your tax return carefully for accuracy with the intention of verifying the correctness of it. Just because your tax return has been selected for review, does not necessarily mean that you have done anything wrong or that you will incur additional tax liabilities and penalties. However, the statistics show that around 75% or more of individuals who are audited, end up owing more taxes. If the IRS does find something wrong, the burden of proof will fall on your shoulders with almost all penalty provisions (fraud is one exception).

There is a wide range of penalties you could incur from an adverse IRS audit decision. Additional taxes could be due after an Examination Report shows that understated your taxes. Here are some possible penalties:

IRS Accuracy Related Penalty

If you have an inaccurate return, you could face a 20% IRS accuracy related penalty on the total tax understatement if it is due to one of the following components below. Realize that certain tax misstatements with regards to gross valuations could trigger a 40% penalty (see accuracy related penalty page).

  • Negligence or Disregard of Regulations – If you do not make any reasonable attempt to the conform to Federal tax code.
  • Disregarding IRS Rules or Regulations – This is when you take a certain position on your tax return that is inconsistent with IRS regulations.
  • Substantially Understating Your Taxes – If you substantially understate your income by the greater of 10% or $5,000.
  • Substantially Misstating the Value of Property – If you substantially overvalue property donated or you substantially undervalue property that is depreciating. See the accuracy related penalty page for thresholds.
  • Substantially Overstating Pension Liabilities – This relates to a business that overstates pension liabilities by 200% or more.
  • Substantially Understating a Gift or Estate – If you undervalue property claimed on an estate or gift tax return by 65% or less (then the market value), which results in an understatement of tax of $5,000 or more.
  • Understatements Related to Reportable Transactions – If you understate tax liabilities due to a reportable or listed transaction (has a significant tax avoidance or sheltering nature) you can face a 20% penalty if it is disclosed and 30% penalty if it lacks adequate disclosure.

IRS Civil Fraud Penalty

Another common IRS penalty that comes about from an adverse audit may be a civil IRS fraud penalty. The penalty is equal to 75% of any Federal tax, that is not paid, that is attributed to fraud. Any part of the tax underpayment not attributed to fraud, may have an accuracy related penalty imposed on it. In other words, any part of the underpayment attributed to fraud cannot be stacked with an accuracy related penalty.

Fraudulently Failing To File a Federal Tax Return

The Fraudulent failure to file penalty is very rare, but can show up in IRS audits if the IRS can prove you filed late (without an extension and past due by at least 60 days) in order to evade paying taxes. The Fraudulent failure to file penalty is not 5% per month (like the normal one) but rather 15% per month for a total penalty of 75% (after 5 months).

IRS Criminal Charges

There is a wide range of criminal charges (misdemeanors and felonies) that can be charged from an IRS audit. This includes criminal fraud charges for filing a fraudulent tax return, trying to evade taxes, failing to file a tax return, or willfully failing to pay estimated taxes or keep records. Criminal fraud charges are less likely that civil fraud penalties.

IRS Interest Can Accrue On Penalties

If you are audited and hit with an accuracy related penalty, a penalty for failing to file on time, or a civil fraud related penalty, interest will accrue from the day the return was due (including extensions) until the penalty is actually paid off. With other penalties, interest does not accrue if the penalty is paid off in 21 days or less from the date the IRS requested payment (if the penalty is less than $100k). If the penalty is more than $100k, you have 10 days to pay until interest begins to accrue.