IRS Tax Audit Penalties & What You Should Know

by AffordableFinancial Group | Sep 26, 2014 | IRS Collections

If you have been summoned for an audit by the IRS, you should know that the odds of escaping without owing additional taxes are slim. In general, the IRS does not spend resources on conducting tax audits unless there’s a good chance for significant revenue to be gained.

What you may not be aware of is that, if you owe more, along with extra taxes, you will likely be assessed tax penalties of some type. The amount and severity of the tax penalties are directly related to the type of deficiency the audit uncovered. But you also have the opportunity to soften the blow or perhaps even qualify for a penalty abatement.

Accuracy Related Tax Penalties

If an IRS audit finds that you filed a substantially inaccurate return, you could be facing accuracy related tax penalties of 20% of the amount you underpaid. In extreme cases, the penalty charged could be doubled to a whopping 40% of your total tax underpayment. The following list indicates the types of accuracy related tax penalties that may result from an IRS tax audit. (About Money)

• Negligence or Disregard of Regulations. Failure to make a reasonable attempt to adhere to Federal tax code rules, such as failing to file a tax return at all
• Disregarding IRS Rules or Regulations. Positions taken on tax returns that are substantively inconsistent with IRS regulations
• Substantially Understating Your Taxes. Understating your income by $5,000 or 10%, whichever is greater.
• Substantially Misstating the Value of Property. Overvaluing of donated property or undervaluing of depreciating property by 200% carries a 20% penalty. Overvaluing donated property or undervaluing depreciating property by 400% carries a 40% penalty
• Substantially Overstating Pension Liabilities. Overstatement of pension liabilities by at least 200% carries a 20% penalty; overstatement of pension liabilities by 400% carries a 40% penalty. No penalty will be applied if the overstatement is $1,000 or less
• Substantially Understating a Gift or Estate. Erroneously stating the value of property claimed on a gift tax or estate tax return at 65% or less of its actual market value carries a 20% penalty. Erroneously stating the value of property claimed on a gift tax or estate tax return at 40% or less of its actual market value carries a 40% penalty. No penalty will result if the understatement results in a tax underpayment of $5,000 or less.
• Understatements Related to Reportable Transactions. There’s a 20% 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 carry a 30% penalty.

Penalties for Failure to File Returns and Pay Taxes

If you are late in filing your tax return or paying your taxes, the penalty is 5% of the unpaid tax, charged each month, up to a maximum of 25%. A minimum penalty of $135 can be charged for returns filed more than 60 days late. Filing your return on time but paying late carries a lighter penalty of 0.5% of the tax you owe each month up to 25%. If you are charged for both tax penalties for the same month, the penalty for failure to file is reduced to 4.5%. (IRS.gov)

If you fail to pay up on taxes owed after an audit, the IRS will assess a penalty of 0.5% for each month the tax is not paid. The clock starts ticking 21 days after the IRS issues the notice. If you pay the amount owed in full within 21 days, you will not be charged an additional penalty.

To add insult to injury, if an audit results in accuracy related penalties, fraudulent failure to file a tax return or civil fraud, the IRS adds interest of 3% annually to the amount of your penalty. If the penalty is $100,000 or less, you have 21 days to pay in full before interest is added. If the penalty is more than $100,000, you only have 10 days to pay up before the IRS begins adding interest.

Civil Fraud Penalty

If an IRS audit results in a charge of civil fraud, you won’t wind up in jail. But the IRS slaps a hefty 75% penalty on any tax underpayment that resulted from fraudulent activity.

There is one sliver of a silver lining to this financially dark cloud — accuracy related penalties cannot be applied to taxes owed as a result of civil fraud. In other words, you can’t be penalized on top of a penalty.

Fraudulent Failure to File a Tax Return

If you mistakenly believe that you were not obliged to file a tax return and the IRS catches up with you through an audit, you’ll be hit with tax penalties for failure to file and failure to pay, but you won’t be charged with fraudulent failure to file a tax return.

Instead, fraudulent failure to file a tax return refers to a deliberate failure to file a return and can be either a civil or misdemeanor criminal offense, although civil charges are much more common. If criminal charges are filed, you could be sentenced to up to a year in jail plus $25,000 in fines for each year that you fail to file. The statute of limitations for criminal charges is six years; there is no statute of limitation for civil charges.

Willful Failure to Pay Estimated Taxes or Keep Records

Willful failure to pay estimated taxes or maintain tax records is considered to be a misdemeanor by the IRS. Just as with fraudulent failure to file a tax return, civil rather than criminal penalties are applied most often for this type of infraction. If the IRS brings criminal charges against you, as the result of an audit or criminal investigation, you could face up to a year in jail and $25,000 in fines for each year for which you are charged.

Filing a Fraudulent Return

Many tax protesters, including actor Wesley Snipes and singer Lauryn Hill, have found themselves on the wrong side of the law because they filed frivolous returns based on claims that income taxes are unconstitutional. Filing a fraudulent tax return is considered a felony, but less serious than tax evasion. If you are convicted of filing a fraudulent return as a result of an audit or as a result of IRS investigation, you could face up to 3 years in prison and up to $100,000 in fines. (IRS.gov)

Tax Evasion

Tax evasion has snared some of the most notorious figures in history, including Chicago crime syndicate boss Al Capone. The IRS defines tax evasion as the willful concealment or misrepresentation of financial resources and assets to avoid paying taxes. If an IRS audit or criminal investigation results in a tax evasion conviction, you could be facing up to 5 years in prison and up to $100,000 in fines.

Audit Reconsideration

If worse comes to worse and you are nailed with more taxes and penalties as the result of an audit, but you disagree with the result, you can request an audit reconsideration. You must request it before you pay any taxes, penalties, or interest that you intend to dispute, not after. If you have already paid the taxes, penalty, and interest, you must request a refund. Submit the following documentation to the same office that conducted your audit. (Journal of Accountancy)

• Statement explaining your reasons for requesting an audit reconsideration
• Form 1099, cancelled checks, bank statements, and similar new documentation
• Copies of previously supplied materials
• Copies of correspondence from the IRS

The IRS is not obligated to grant your request. But if you can demonstrate any of the following circumstances, your request for audit reconsideration should be approved.

• You did not appear for the audit
• You moved and did not receive proper notice for the audit
• You submitted documentation that the IRS refused to consider that would reduce or eliminate the taxes, penalties, or interest you owe
• You have new documentation to support your case
• You file a return that shows the correct tax to replace a return created by the IRS because you previously failed to file a return
• The IRS committed math or processing errors in calculating the tax you owe

The IRS should respond to your request for an audit reconsideration within 30 days, although the wait could be longer. Bear in mind that tax penalties and interest continue to accumulate during that time. If you are suffering financial hardship due to delays in processing your audit return, you can ask for your request to be expedited.

Offer in Compromise and Penalty Abatement

If your request for audit reconsideration is denied, you may still be able to ease your burden. If you cannot pay the full amount of tax that you owe, you may request an Offer in Compromise, which settles your tax obligation for a fraction of what you actually owe. Be forewarned that the IRS accepts only a small percentage of Offers in Compromise. Obtaining expert advice from the experts at Affordable Tax Relief will improve your odds.

Under certain circumstances you may request a penalty abatement, which results in some or all the penalties you have been charged being waived. The IRS generally approves requests for penalty abatement based on reasonable cause or administrative waivers. To request a penalty abatement, file IRS Form 843 along with copies of any documentation you may have to support your request.

When Does the IRS Pursue Criminal Charges?

by AffordableFinancial Group | Sep 18, 2014 | IRS Collections

Statistically, your chances of being charged with criminal tax fraud or tax evasion by the IRS are minimal. The IRS initiates criminal investigations against fewer than 2% of all American taxpayers. Of that number, only about 20% face criminal tax charges or fines.

Related Article: The IRS Criminal Investigation Process

Unofficially, the minimum amount of unpaid taxes required to trigger an IRS criminal investigation is $70,000. And since the majority of Americans don’t even earn that much money, it’s easy to see why ordinary taxpayers need never worry about facing tax evasion or tax fraud charges.

While honest mistakes or even negligence generally won’t trigger a tax investigation, perpetrating fraud very well might. IRS agents are trained to recognize signs of criminal tax fraud and evasion. Exhibiting behaviors the IRS calls “affirmative acts” could eventually result in that fateful knock on the door from the IRS.

Negligence versus Tax Fraud

Back in the day, it seemed like the IRS was lying in wait, prepared to strike unsuspecting taxpayers at the slightest sign of tax error. These days the IRS is more tolerant of mistakes made by honest taxpayers.

When the circumstances are not clear cut, the IRS frequently errs on the side of giving the taxpayer the benefit of the doubt. Miscalculating the amount of your Earned Income Tax Credit is a mistake that could cost you a significant sum of money, but it isn’t usually considered to be tax fraud. Artificially concealing $800,000 of income by keeping two sets of books? Tax fraud. (Nolo)

Evidence of Tax Fraud

Four so-called elements of tax fraud are recognized by the IRS: deception, misrepresenting material facts, submitting false or deliberately altered documents and failing to submit critical documents, such as tax returns. Several elements of fraud must occur together to trigger IRS tax fraud charges. But a single element that occurs in an especially blatant fashion may generate IRS tax fraud charges.

For instance, failure to submit a tax return for a single year is not usually considered to be an element of tax fraud. On the other hand, unless your income is extremely low, failing to file any tax returns ever could very well cause the IRS to initiate a criminal investigation against you.

Badges of Tax Fraud

The list below, taken from the IRS.gov website, represents several “badges of fraud” the IRS looks for when determining whether to file criminal charges.

Badges of tax fraud fall into four general categories: improper reporting of income, unjustified deductions or tax credits, inadequate record keeping and outright illegal behavior. As with elements of fraud, IRS agents are inclined to give taxpayers the benefit of the doubt. They’ll impose penalties for taxpayers in arrears rather than bringing criminal charges against them.

• Understatement or omission of substantial sums of money
• Fictitious deductions
• Maintaining “shadow” sets of accounting records
• Deliberate destruction of records
• Evidence of consistent underreporting of income
• Obviously nonsensical explanations for behavior
• Refusing to cooperate with an auditor or examiner·
• Deliberately concealing assets, as in overseas tax shelters
• Illegal activities
• Dealing exclusively in cash
• Maintaining obviously inadequate records
• Indicators of Fraud

The IRS categorizes indicators of tax fraud into six broad categories: income, expenses and deductions, books and records, income allocation, methods of concealment and taxpayer conduct.

Just as with elements of tax fraud and badges of tax fraud, the difference between negligence and criminal conduct is often a matter of extent.

Indicators of fraud usually include an element of deliberate conduct as well. An extensive list of actions that constitute indicators of fraud are available on the IRS website, but the examples below should provide a general idea of how the IRS views indicators of fraud.

Example #1:

Forgetting to include income from a W-2 form is not considered an indicator of income fraud. Insisting on being paid cash wages for a job and refusing to list any income from that job on your federal income tax return would be considered to be an indicator of income fraud.

Example #2:

Miscalculating the percentage of business versus personal use for your computer is not considered an indicator of fraud for expenses and deductions. Attempting to deduct the entire cost of your vacation to the Bahamas because you answered a single work-related email from your hotel room WOULD be.

Don’t Be Evasive

In general, if you suspect that a particular type of conduct is disallowed by the IRS, you shouldn’t do it. If you go ahead and do it anyway, you run the risk of being cited for tax evasion or tax fraud. And if you do receive that dreaded knock on the door from the IRS, you should not be surprised.

Additional Tax Tips:What to do during an IRS Audit
How to survive an IRS tax audit

How to Know if the IRS Is Auditing You

by AffordableFinancial Group | Aug 27, 2014 | IRS Collections

You may be under the impression that if you’re being audited, you’ll find out by a strong knock at your front door. Unless you’re in serious trouble, this won’t be the case.

How will you know if you’re being audited?
Short Answer: The IRS will let you know directly.

The only way you’ll know for certain if the IRS is auditing you is if the IRS tells you – either by phone or mail. If your initial contact is by email, it’s likely a scam and you should report it.

Who is most likely to be audited?
According to Bloomberg News, only 1% of all tax returns each year are audited. But there are factors that increase your chances of being targeted for an IRS audit.

• Being rich. 12.5% of all tax returns for those who make over a million dollars a year.
• Mistakes on your tax return. This could be anything from not reporting all of your income, your numbers not matching with your employer-provided W2s, or even math errors on your tax return. Don’t round your numbers.
• Self-employed. The IRS will look at your deductions to see if they are the typical amount for someone in your industry. Travel/entertainment and automobile deductions are watched especially closely. While a home office is no longer an immediate reason to suspect an audit, taking the deduction needs to be backed up with detailed records.
• Large charitable donations. If you only make $20,000 a year and yet donated a substantial amount of money, watch out.
• Your associates. If your business partner in a firm or a close relative is being audited, you could be too.

Types of IRS Audits
There are three types of IRS audits, depending on the complexity of your return, the number of questions the IRS has and the dollar amount involved.

• Correspondence Audit – An IRS tax audit conducted entirely by mail. The IRS likely has a short checklist of questions to ask you about your income, expenses, or itemized deductions.
• Field Audit – The IRS will send an agent to visit you in person in your home or business. They will want to inspect the records you’ve kept.
• Office Audit – You are requested to meet with an agent at their nearest office and bring your paperwork with you to the meeting.

If you are audited there are four things to remember:

• Respond to their letters within the deadline given on the notice. If you need more time, you’re far more likely to get an extension if you ask for it before the deadline’s passed.
• Gather all the documentation you need to answer their questions and provide copies to the IRS. (Never give them your original documents, they aren’t responsible if anything is lost.)
• Bring the right representation. Not your Uncle Bill but a CPA or tax attorney. This is not the time for amateur help or to go it alone.
• Be polite and respectful. But don’t volunteer anything. If the agent wants to expand the audit, you are entitled to more time to answer any new questions that may arise.

An IRS tax audit can be a painful experience but you will get through it with thorough preparation, and if needed, expert help from Affordable Tax Relief.

Additional Tax Tips:

The IRS Criminal Investigation Process
What to do during an IRS Audit
What does the IRS look for in an audit?
IRS penalty and interest rates