Tax Audit Penalties: What Happens if You Get Audited and Fail

 September 3, 2021
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As the old saying goes, “In this world, nothing is certain except death and taxes.” While Benjamin Franklin was correct about filing your tax paperwork every year, the chances of you being scrutinized by the IRS are few and far between.

However, there’s always the possibility that you could face an audit, and, if you’re found to have misrepresented your income, tax audit penalties can be serious. Consequences range from stiff fines to criminal charges, and you could be buried under a mountain of paperwork.

Below, find out what happens if you get audited and fail to demonstrate you filed your taxes accurately.

What is an audit?

An IRS audit is an extensive review of your taxes and financial records to ensure you reported everything accurately. These documents can include W-2 and 1099 forms as well as any money you make through any side gigs. Though most people have a less than 1% chance of being audited, it’s not worth the risk to fudge your numbers or not double check your work.

If you’re chosen for an IRS tax audit, it doesn’t necessarily mean you were flagged because of an issue. You may be picked for an audit because…

  • You were randomly selected via a computer formula based on IRS statistics that compares your tax returns to similar returns.
  • An individual or business you have financial connections to is also being audited. This may include investors or business partners.

If the IRS audits you and you’re concerned about what they may find, you can (and probably should) hire a professional to represent you and your interests, though, it can be pricey.

What happens if you get audited and fail?

If the IRS does select you for an audit and they find errors, the penalties and fines can be steep, according to Joshua Zimmelman, president of Westwood Tax and Consulting. You can even face prison time for tax fraud or evasion.

“If you don’t pay your tax liability by the due date, the IRS will charge you a late payment penalty,” Zimmelman says. “Even if you file on time, you may still be charged a late payment penalty if you underreport your income and the IRS finds out.”

Undergoing an audit can be a time-intensive and costly process that involves the IRS reviewing years of documentation and conducting surveillance, search warrants, subpoenas and even in-person interviews.

Keep in mind that even if the IRS may have only flagged one return for audit, they can review any return from the past several years. Typically, the IRS reviews your returns from the last three years; however, if the audit turns up discrepancies, they can review any return from the past six years.

If they find more issues, they can add penalties and fines for every year they find problems. If you made tax mistakes for the past several years, you could end up owing thousands for taxes you misrepresented.

“If you’re found guilty of tax evasion or tax fraud, you might end up having to pay serious fines,” says Zimmelman.

What are the types of tax audit penalties?

Now that you know what happens if you get audited and fail, let’s review the potential tax audit penalties.

Civil Penalty

After a review of your tax returns, if the IRS finds inconsistencies, there are several tax audit penalties you could face in civil court.

  • Negligence: The IRS may fine you for negligence if it finds that you have “recklessly or intentionally” brushed aside federal revenue laws. You can avoid paying a negligence penalty if you can demonstrate that your actions were reasonable based on the information you had and that you “acted in good faith.”
  • Civil fraud penalty: If you defraud the IRS and underpaid on your taxes, you can be fined 75% of what you should have paid on top of the taxes you’ll owe. If the IRS has a strong case that you committed fraud, they may involve the IRS Criminal Investigation Division, and you may be criminally charged. The IRS does not consider negligence or a misunderstanding of tax law as fraud.
  • Frivolous tax return penalty: A frivolous tax return is determined when:
    1. You do not provide all the information needed to evaluate what your appropriate tax return or payment should be.
    2. The information you provided on your taxes is largely inaccurate.

If the IRS finds that you filed a frivolous tax return, you may be subject to a $5,000 fine. If you jointly filed your taxes with your spouse, both of you may be fined $5,000 each.

Criminal charges

Besides potentially owing thousands in IRS penalties, fees and interest, you could also face criminal charges.

“Tax fraud is a felony and punishable by up to five years in prison,” says Zimmelman. “Failing to report foreign bank and financial accounts might result in up to 10 years in prison.”

Criminal investigations and charges start when an IRS auditor detects possible fraud during their audit of your returns. Courts convict approximately 3,000 people every year of tax fraud, signaling how serious the IRS takes lying on your taxes.

Other consequences

Not reporting all of your income can also have serious ramifications when it comes to making major purchases like buying a home or car.

“If you underreport your income, it might hurt you when you try to buy a house or apply for a personal loan,” says Zimmelman. “You might not get it if it looks like you cannot afford to pay it back, so lying on your taxes may hurt in that respect.”

When mortgage companies and banks review your application, they request copies of your tax returns to check your total income. If you lied about your income to lower your tax liability, your full income won’t be on the return. That means you may be denied for the loan you need, hurting your financial future.

Can you appeal the results of an audit?

If you disagree with the results of an IRS tax audit, there are a few ways you can appeal the decision.

  • Alternative Dispute Resolution (ADR): An ADR, or mediation, allows those who don’t agree with the IRS regarding their case to work with an appeal officer who will act as a go-between for you and the IRS. Choosing the mediation route will allow you to bypass court expenses as well as a long-running appeals process. Going with a mediator is completely voluntary and no one involved can force you to come to an agreement.
  • File a protest: If you believe the IRS’s decision in your case is incorrect or inappropriate, you can request an appeal hearing and file a protest. You must mail in a written appeal that will first be reviewed by the IRS Examination Office. If that department does not resolve your case, the next step will be to have an appeals hearing. To prepare for the hearing, you could…
    • Represent yourself
    • Hire an attorney
    • Hire a certified public accountant (CPA)
    • Use an enrolled agent

From there, the IRS Office of Appeals will review your dispute and provide a ruling. Be prepared to offer up any additional paperwork or documentation that is requested.

How do you file an amended tax return?

If you make a mistake while filing your taxes, you can file an amended tax return. In your amended tax return, you can provide an update to your tax return and inform the IRS of the error.

The following is how to file an amended tax return:

  1. Get your original tax return that you filed with the IRS and list out the corrections that need to be made.
  2. Once you’re ready to file, fill out the 1040X form and save a copy for yourself.
  3. You’ll need to mail in the 1040X form to the appropriate IRS address. This entirely depends on what state you live in or if you live outside the U.S.

If you’re worried about being able to file or make payments on any taxes owed, consider filing an extension with the IRS.

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