You’re worried about what happens if you get audited and fail. It won’t be the end of the world but you may face some IRS audit penalties as a result of issues with your tax returns. Audits can be a scary experience to go through.
The chances of being audited are slim. Of the over 160 million individual income tax returns that were filed in 2021, the IRS only audited 0.4%. That’s 4 out of every 1,000 returns. Nevertheless, it’s always best to know what can happen if you get audited and fail.
What happens if you get audited and fail?
If you get audited by the IRS and fail, it’s not the end of the world. Getting audited by the IRS can already feel like a nightmare. You might not know what happens if you fail an IRS audit and you’d hoped that you never have to find out.
What will happen if you fail the audit depends largely on what the IRS has assessed. It will impose tax penalties if errors are found in your tax returns. There's also the possibility of jail time in serious cases of tax evasion and tax fraud.
The IRS may normally flag one return for audit but it does have the authority to audit returns from the past several years. Typically , it will audit your returns from the past three years but if additional discrepancies are discovered, it can review returns from the past six years to make an assessment. The audit timeline will depend on the complexity of your case. See FAQ section for more information on the audit process timeline.
Generally, if you fail an audit, you get hit with a bigger tax bill. The IRS finds that you didn't pay the correct amount of taxes so it utilizes the audit to recover them. In addition to penalties, you're required to pay the additional taxes as well as the interest on those taxes. This does not mean you’ll end up in jail.
Not all IRS audits will result in a penalty. If you're able to justify the items being reviewed on your return, the IRS will conclude the audit without imposing any charges or penalties. What happens if you get audited and don't have receipts to make justifications? The IRS will typically disallow the deduction but the auditors do provide some leeway for the reconstruction of expenses.
Common reasons for IRS tax audit penalties and fees
Figuring out the IRS audit red flags isn't simple since they don’t disclose the precise reasons behind why a taxpayer may be selected for an audit which ultimately leads to a tax audit penalty. However, there are a few common reasons why you might find yourself on the hook for penalties and fees.
Not responding to an audit notice
You can’t wish away an audit. Some people believe that ignoring IRS audit will make it go away but that couldn’t be further from the truth. You’ll end up creating more problems for yourself if your idea is to just not respond in the hope that the audit will take care of itself, or better yet, never followed up.
So what happens if you don't respond to a tax audit? The audit notice that you receive from the IRS will have a deadline for you to respond. If you keep ignoring subsequent notices, you could lose your right to dispute the audit in Tax Court. The IRS will then be able to decide all of the issues against you and begin the process of collecting additional taxes, penalties, and interest. If this turns out to be the case, you should call an IRS audit attorney to help you out.
Underestimating the amount of tax due
Estimations are based on predictions and you may underestimate the amount of tax that you owe to the IRS. Taxpayers are required to withhold tax or make quarterly estimated tax payments as this amount has to be estimated.
The IRS imposes penalties for amounts that are below estimates or have too little tax withheld. Individuals have to pay either 100% of the previous year's tax or 90% of the current year's tax to avoid an underpayment penalty.
Deductions that you're unable to justify
You're allowed to take deductions that you're entitled to but it's important to be mindful of the rules. Deductions that appear out of the ordinary can trigger an audit and the IRS imposes penalties for deductions that you're unable to justify.
You’ll be provided with an opportunity to justify the deductions that you’ve claimed on your tax returns. As long as you have receipts and other documentation to support the claim, you’ll most likely be able to avoid the penalty.
IRS audit penalties
You could be looking at any number of IRS audit penalties depending on the scale of the tax problem you have. But you won’t have to calculate the IRS audit penalty on your own. They will tell you exactly how much you’re on the hook for.
There's a defined purpose for which the IRS charges penalties. According to the Internal Revenue Manual’s Penalty Handbook, the purpose of these penalties is to encourage voluntary compliance by informing taxpayers about compliant behavior and the consequences they would face for non-compliance.
1. Accuracy related penalties
If an amount reported on a return is later adjusted and results in a tax increase, the IRS may assess a penalty on that amount. This penalty can range between 20-40% of the tax increase.
How much are IRS penalties in matters where the accuracy of the return is called into question depends on various tax issues such as considerable understatement of tax, significant valuation misstatements, transfer pricing adjustments, negligence, or disregard of rules or regulations.
2. Tax fraud penalties
The filing of a false tax return is considered to be fraud by the IRS and it's a criminal offense. Taxpayers who are convicted of fraud or of aiding another taxpayer in committing fraud may be subject to forfeiture of property and possibly even jail time.
The IRS doesn't prosecute tax fraud cases, the Department of Justice does. The process for a taxpayer's conviction and sentencing goes through the court system. If convicted, the taxpayer can be hit with tax fraud penalties based on the nature of their tax case.
3. Failure to fine penalties
This penalty applies when you don't file your tax return by the due date. The taxpayer's tax balance will thus be assessed a late filing penalty. It's 5% of the amount of unpaid tax per month the return is late but capped at a maximum of 25%.
There may also be a minimum penalty of $435 for late filing of an income tax return. That's if your return was over 60 days late or 100% of the tax required to be shown on the return, whichever is less.