Come tax season, fear of triggering an IRS audit runs high. While we’ve all heard horror stories about the Tax Man taking his pound of flesh, it’s best to know the real penalties and the options you have if facing one.
The best advice.
That is not having to deal with penalties in the first place. Many of the issues that raise red flags and trigger a second look are easy to avoid. Work with a professional bookkeeper or accounting firm, and make sure you do the little things (like keeping detailed records, especially for vehicle use. Vehicle-related deductions are always a favorite place auditors love to scrutinize). However, even the most careful can still find himself or herself in front of an auditor.
If you do find yourself in the sticky situation of an IRS Audit, always seek out the help of a tax professional.
What should you expect for penalties and how bad can they be?
(And keep in mind, the penalties are on top of what you still owe!)
Since audits are rarely random, getting that notice will likely mean it you’re going to owe – the original tax and the penalties. So, what will it cost you?
Penalties vary based on the egregiousness of your error. Accuracy matters! Or, in this case, the degree of inaccuracy can be a killer. Penalties can range from 20-40% of the amount you underpaid.
Below is a list of reasons audits are triggered with their accuracy-related penalties you could face in an audit (courtesy of Optimized Tax Relief):
Misstating the Value of Donations & Property. Overvaluing of donated property or undervaluing of depreciating property by 200 percent carries a 20 percent penalty. Overvaluing donated property or undervaluing depreciating property by 400 percent carries a 40 percent penalty.
Overstating Pension Liabilities. Overstatement of pension liabilities by at least 200 percent carries a 20 percent penalty; overstatement of pension liabilities by 400 percent carries a 40 percent penalty. No penalty will be applied if the overstatement is $1,000 or less
Understating a Gift or Estate. Erroneously stating the value of property claimed on a gift tax or estate tax return at 65 percent or less of its actual market value carries a 20 percent penalty. Erroneously stating the value of property claimed on a gift tax or estate tax return at 40 percent or less of its actual market value carries a 40 percent penalty. No penalty will result if the understatement results in a tax underpayment of $5,000 or less.
Understatements Related to Reportable Transactions. 20 percent penalty for understating tax liabilities due to a tax shelter or tax avoidance transaction that are disclosed. Inadequately disclosed tax shelters or tax avoidance shelters that carry a 30 percent penalty.
While not usually a trigger for an audit (unless it’s habitual), here’s a look at some other penalties the IRS can levy:
Forgetting to file, filing late, and paying late will cost you too.
If you pay your taxes late, the IRS charges 5% of the unpaid tax as a penalty. That’s every month with up to a 25% penalty maximum! If you’re over 60 days late, a minimum charge of $135 can be levied, too. If you are short on funds, you can mitigate some of the penalties by filing on time and paying late. This results in a smaller penalty of .5% per month. (IRS.gov)
The rules change a bit if you are late with an Audit payment. If you don’t pay in full after 21 days of your notice, penalties begin amassing at .5% per month. Worse – if you have accuracy-related penalties, fraudulent failure to file, or civil fraud assessments, you will be charged 3% of the amount owed annually.
For less than $100,000 in fees, you have 21 days to pay. For $100,000 and above, you have 10 Days! Then the interest begins to accrue.
Thinking of skipping those quarterly payments? Don’t!
The US tax system is ‘pay as you go’. As an employee, your employer withholds and sends your tax payment for you. If you are self-employed, you’re responsible for making estimated tax payments. Failing to make these payments or paying them late will result in penalties and fees.
Civil charges are the most common penalty in this department. If you’re late making a quarterly payment, or don’t make one at all, the IRS charges you interest on the money you owe for each day you are late. Criminal charges could also be levied here, but usually only in conjunction with an audit and other criminal investigations.
Protest Returns – They’re not as funny as they seem.
In the past, celebrities have filed fake tax returns to protest the income tax. Filing fake taxes is a felony, but less serious than actual tax evasion (the big kahuna). If you are convicted of filing a fake return, you can face up to 3 years in prison and $100,000 in fines.
On a side note, with so much tax return identity theft going on, I hope they give this to the guy who robbed me!
Tax Fraud.
The IRS defines tax fraud as entities who engage in tax evasion schemes to lower their tax burden. Don’t be tempted to hide income in someone else’s name!
IRS has a choice to pursue fraud cases as civil or criminal. There is more burden of proof (and paperwork) for a criminal case than civil one. Just like CSI, the IRS will almost always pursue the criminal case first. If they fail to convict, they still have the civil case to pursue. The bad news? The penalty in a civil case is a whopper: 75% of the assessed unpaid tax.
Fraudulent Failure to File.
This isn’t for people who erroneously believed they didn’t have to file. If you get caught in an audit for that, you’ll get hit with the standard late penalties. This is for those who deliberately failed to file. If you do and have a large tax burden, the penalty is severe:
For criminal charges, it is up to a year in prison and $25,000 in fines for each year you failed to file. The statute of limitations for prosecution is 6 years for criminal cases, increasing the risk of getting caught. For lesser-fined, civil charges, there is no statute of limitations. The good news – the IRS still prefers the criminal route.
Tax Evasion – It’s how they got Al Capone.
Evasion, per the IRS, is defined as any person who willfully attempts to evade or defeat any tax imposed by concealment and misrepresentation of financial assets. This felony comes with a penalty of up to 5 years in prison and $250,000 fine for individuals ($500,000 for corporations). That’s per instance they discover. It put old Al away for life!
It’s Not Over Till It’s Over.
So what happens if you disagree with the auditor’s findings (or miss your audit meeting)? You have the right to request an audit reconsideration. It’s best to request this before you pay any fines (trying to get a refund on fees paid is a whole other ordeal). While the IRS is not obligated to agree to a reconsideration, meeting any of the criteria below usually results with an approved reconsideration:
- Failure to appear at original audit
- Did not receive audit notice due to a move.
- You submitted evidence that would lower your tax burden that the IRS chose not to allow (you are petitioning for a reconsideration of this).
- There is new documentation to help your case.
- You have filed a new return that has better information than one generated by the IRS in a Failure to File case.
- The IRS committed math or processing errors in calculating your penalties and tax burden.
Keep in mind it typically takes 30 days for the IRS to respond to these requests and failure to pay or paying late will result in further penalties. If you are enduring a financial hardship, you can request for your file to be expedited.
Offer in Compromise – the Last Resort.
If you’ve exhausted all your resources and are left with more in taxes due plus fees and penalties than you can reasonably put together, you can now submit an Offer in Compromise. This allows you to settle your tax debt for less than the full amount you owe. The IRS will look at your specific circumstances and will generally approve an offer to compromise if they feel the amount you offer is what they would expect to collect in a reasonable period of time. If you choose to make an offer, make it reasonable!
You can also request a penalty abatement by filing IRS Form 843.
It may be possible to qualify for administrative relief from penalties for failing to file a tax return, not paying on time, and/or failing to deposit taxes when due under the Service’s First Time Penalty Abatement policy if the following are true:
- You didn’t previously have to file a return or you have no penalties for the 3 tax years prior to the tax year in which you received a penalty.
- All currently required returns have been filed or you filed an extension of time.
- You have paid, or arranged to pay, any tax due. ~IRS.gov
Hopefully, you won’t find yourself facing an audit. If you do, at least you know what you can be facing and your options.
Image credit: https://www.etax1099.com