Receiving a notification that your tax account will be audited by the IRS is already stressful – even more so in the case that there are errors found in your federal income tax return. Most of the time, if you fail an IRS tax audit, you will be issued a higher tax bill. However, if the Internal Revenue Service uncovers evidence of tax evasion or tax fraud, the taxpayer may be subject to harsher penalties such as jail time.
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- If you fail your tax audit due to a mistake, you may observe an increased tax bill or face financial penalties. If you are found guilty of tax fraud or tax evasion upon being audited, you may face more serious fines or be sentenced to up to five years in jail.
- The most common causes for a taxpayer to be issued tax audit penalties include ignoring or failing to respond to a tax audit notice, the understating of tax liability on their federal income tax return, or claiming deductions on their tax return that they cannot justify.
- Some examples of IRS audit penalties include failure-to-file penalties, accuracy-related penalties, false credit or tax refund claim penalties, employee tax miscalculation penalties, and tax fraud penalties.
What Happens If You Are Audited And Found Guilty?
If you are audited by the IRS and are found guilty, this means that the auditor disagrees with the information that was reported on your federal income tax return.
There is a significant difference between failing a tax audit and being found guilty of criminal tax evasion. Depending on the situation and the reason the mistakes were made in the tax audit, there are different types of consequences, ranging from an increased tax bill to potentially facing prison time.
What Is An IRS Audit?
IRS audits involve an IRS representative, the auditor, analyzing a submitted tax return to verify that all claims are input correctly and that the taxes people owe are paid in full. This process involves the taxpayer sending supporting documentation and receipts to the auditor for evaluation.
While some tax returns are flagged due to a discrepancy, often, tax returns are randomly selected for audit for accuracy verification. Certain tax deductions may also trigger an IRS audit, but the guidelines for which returns are most likely to be selected for the audit process are unclear. For this reason, just because an account is selected for an audit does not mean there is an issue with the tax return.
There are several possible outcomes of an IRS audit:
1. The IRS accepts the tax return as accurate after the supporting documentation has been submitted and verified.
2. The IRS observes an understatement of taxes and the taxpayer must pay the additional tax liability owed.
3. The IRS claims there was an understatement of taxes but the taxpayer disagrees, so the case is taken to tax court.
Common Reasons The IRS Issues Tax Audit Penalties And Fees
Here are some of the common reasons taxpayers will be issued fees and penalties related to a failed tax audit:
The Taxpayer Ignored A Tax Audit Notice
If taxpayers receive an IRS audit notice in the mail but fail to respond to the letter by the due date, they may receive additional fees and penalties on top of any items listed within the notice. Additionally, failing to respond by the deadline may take away the taxpayer’s right to appeal the audit notice in tax court.
The Taxpayer Underestimated Their Tax Liability
Many common tax audits notify taxpayers about an error in their reported tax liability, outlining an updated tax bill with the additional taxes and interest due to the understatement. Under the circumstances that the IRS determines the understatement was due to a harmless error, only the additional tax and interest will be added to the updated tax bill.
However, if the IRS determines the understatement was due to intentional tax evasion, the taxpayer may be subjected to criminal fraud penalties, depending on the situation.
The Taxpayer Claimed Tax Deductions They Cannot Justify
If a taxpayer is audited and cannot justify the personal, business, or other itemized deductions they claimed on their federal income tax return, they may face an IRS audit penalty for understated taxes. Tax penalties due to overstated tax deductions overlap with penalties due to understated taxes.
Types Of IRS Tax Audit Penalties
There are several types of IRS tax penalties that may be issued in the case that you have violated the IRS tax code.
The IRS issues a late filing penalty for taxpayers who fail to file their federal income tax return by the annual due date. The penalty for late filing is 5% of the unpaid tax for each month the return was late, capping at a maximum fine of 25%. There is sometimes a minimum tax penalty of the lesser of $435 for late filing of tax returns if the return was late by over 60 days or 100% of the tax that would be depicted on the return.
Inaccurately reporting taxes on a submitted income tax return is another reason that the IRS may issue tax penalties for the underpayment of tax liability. This outcome can arise when the IRS observes an understated tax due to negligence or if the taxpayer’s tax liability is substantially understated.
Understatement of taxes due to negligence includes the disregarding of tax rules, failing to provide documentation or proof regarding credits or deductions claimed on a tax return, or failing to mention self-employed income or independent contractor income from a 1099 form. Substantial understatement of taxes is considered 10% or $5000 less than what was actually due.
Either of these situations can result in a civil fraud penalty, a fee that equates to 20% of the understated tax.
False Credit Or Tax Refund Claim Penalties
Erroneously claiming tax credits that do not apply to a financial situation or claiming an inaccurate tax refund can result in an IRS penalty that is valued at 20% of the money in the erroneously stated claim.
Employee Tax Miscalculation Penalties
Taxpayers can be audited for income tax returns as well as other tax returns, such as employer tax returns, that are submitted to the IRS or another local or state government agency. If a business owner makes a miscalculation while listing the amount of federal withholding tax for payroll, Social Security tax, or Medicare tax was withheld from their employee’s paychecks, they may face penalties if a tax audit reveals these inaccuracies.
Tax penalties can be applied for a range of offenses involving employee tax miscalculations, such as late submission of tax forms, late payments of tax liabilities, or failing to pay estimated taxes, for business taxes or self-employment taxes, throughout the tax year. Depending on the type of tax return involved and the offense, there are different tax penalties and fines that may be applied to the tax bill. It is important to note that these penalties are different from specific IRS audit penalties, and the taxpayer may be charged whether they are audited or not.
One of the most common types of tax penalties that may be observed after the auditors’ assessment of the tax returns is the Trust Fund Recovery Penalty. This tax penalty is applied due to the miscalculation and consequent underpayment of withheld employee taxes, and in this circumstance, the employer will be responsible for paying the penalty equating to 100% of the initial tax bill they would have paid for their employees.
Tax Fraud Penalties
Intentionally underreporting or erroneously reporting tax information on a federal income tax return is considered tax fraud by the IRS and is a criminal offense. The IRS civil fraud penalty is 75% of the value of understated taxes on an income tax return, which is one of the worst IRS audit penalties a taxpayer could be charged with. If a taxpayer is convicted of tax fraud or is found to have aided other people in fraudulent tax activities, the consequences could include having their property forfeited or receiving a jail sentence.
What Happens If You Are Found Guilty Of Tax Fraud Or Tax Evasion?
If you are audited by the IRS and the audit results in you being found guilty of tax evasion, you may face criminal charges, as it is against the law to intentionally avoid paying taxes. Making a mistake on your tax return or using legal tax avoidance methods that abide by tax laws are not considered tax evasion, so severe tax evasion consequences aren’t applicable.
For you to be officially charged with tax fraud or tax evasion, the IRS must be able to prove that you willfully and intentionally avoided paying your tax liability.
Here are some examples of illegal tax evasion:
- Intentionally filing a false tax return
- Hiding or understating income from the IRS
- Transferring assets to avoid paying taxes
- Having inaccurate bookkeeping records for the purpose of filing taxes
- Destroying financial or tax documents
If you are found guilty of tax fraud or tax evasion, the fines and penalties can be severe. Individuals may face a fine of up to $100,000. Businesses and corporations could face an even more significant fine of up to $500,000. Depending on the situation, as tax fraud is a felony, if you are convicted of tax fraud or tax evasion, you could face up to five years in prison.
The consequences of being convicted of tax evasion are severe, so if you are facing a criminal investigation for tax fraud, hiring a tax professional to represent your case will provide you with the best possibility of reducing your sentence and minimizing your charges.
Frequently Asked Questions
What Is The Worst-Case Scenario Following A Tax Audit?
The worst possible outcome following a tax audit is that you will be convicted of criminal tax fraud or tax evasion and be sentenced to jail time. This outcome is only in the situation when taxes were willfully evaded. Therefore, if you make a mistake on your tax return, you will not go to jail, as it was accidental. Instead, you may be subject to a penalty.
Am I In Trouble With The IRS If I Am Being Audited?
Receiving a notice from the IRS that you are being audited does not necessarily mean you are in trouble, as the IRS conducts randomized audits as well as audits for flagged tax returns.
What Are The Consequences Of Being Audited By The IRS?
Depending on the outcome of the tax audit, the potential consequences of being audited by the IRS include receiving a tax refund, owing additional tax liability, or owing additional penalties, if the discrepancies in the tax return were due to a mistake. Intentional tax evasion revealed within a tax audit may result in the taxpayer accruing additional penalties or potentially facing jail time.
If you have received a tax audit notice from the IRS and want to ensure you respond correctly to the situation to resolve your mistake and minimize your charges, receiving professional tax help from a tax attorney can be valuable. Contact us at Ideal Tax today for a free tax consultation and to learn if our licensed tax professionals can assist you throughout the auditing process, providing their knowledge of tax filing and the tax audit investigation process to achieve the best outcome for you.