An audit from the IRS is rare – but when the IRS does decide to incur an investigation, they tend to be thorough. Most IRS investigations are routine and result in minor changes if anything at all. These will usually fall under so-called correspondence audits, wherein the IRS requests certain documents to double-check the information on your return and sends you a notice of any amendments made to your return because of their correction, which may or may include an overdue balance for previously missed taxes.
If you’re lucky and were as honest with your taxes as possible, the IRS might find that their red flag was erroneous or that your return only had a minor math error. In some cases, the IRS might even discover an overpayment of taxes beyond what was anticipated, and you receive a larger tax refund as a result. But when an audit reveals more than a simple math error, the IRS may penalize you depending on what their investigation discovered.
What Are IRS Audit Penalties?
There isn’t such a thing as audit-specific penalty. There are tax penalties, but these relate not only to what an audit might reveal but to various offenses. For example, if a business is late on payroll taxes, the IRS may impose specific penalties on individuals responsible for allocating and managing payroll tax payments.
That being said, all of these IRS audit penalties can be brought in connection with an IRS investigation. They can help reveal why being accurate with your tax returns is essential, especially if you are self-employed or manage a business of your own, and they help illustrate how the IRS coerces cooperation in taxpayers who might be unwilling to face their tax responsibilities. Let’s go over the most common examples.
1. Accuracy-Related IRS Audit Penalties
Most penalties levied by an audit end up being accuracy-related tax penalties. These are only relevant in cases where an audit reveals an underpayment of $5,000 or at least 10 percent of your taxable income. The penalty for an inaccurate tax return is the money owed plus an additional 20 percent. Accuracy-related tax penalties are levied most often after an audit because they cover a wide variety of mistakes and offenses.
We’ve mentioned failing to account for at least a tenth of your income or $5,000. Still, the IRS will also penalize you for failing to mention or understate gift value or the value of your estate in the estate tax return/gift tax returns, as well as understating transactions that must be reported. The accuracy-related penalty of 20 percent may be increased to 40 percent in cases of gross valuation misstatements and failure to disclose foreign assets.
2. Fraud Penalty
What if the IRS determines that you did not make a colossal mistake but willingly and knowingly tried to defraud the government? In these cases, where a clear distinction can be made – and the IRS has the evidence to back it up – the government can penalize you with up to 75 percent of the unpaid tax due to fraud.
This civil penalty can be levied in addition to accuracy-related tax penalties. To levy a civil fraud penalty, the IRS must have convincing evidence that shows you knowingly tried to defraud the government out of tax money through intentional underpayment or hiding financial information.
3. Jail Time
You need to incur a substantial tax debt or have seriously defrauded the government to call for a criminal charge – in which case the IRS can see to it that you land in jail. Not a penalty per se, but the IRS can turn civil charges into criminal ones. Even refusing to pay your tax debt is technically a crime, although not one the IRS usually calls people out on.
Of all the audits the IRS can perform yearly, only about two percent result in a criminal charge. These range from as little as a few months to years behind bars. There is a lot of procedure to go through before a person’s tax fraud can result in a criminal charge, so the IRS tends to resolve tax debts by coercing payment through its collection actions. After all, it’s best not to be on the IRS’ wrong side.
4. Failure to File
Aside from the more common IRS audit penalties, the IRS can levy several stacking fines depending on the taxpayer’s faults. A failure to file a penalty is a flat 5 percent per month in which a tax return is due and late, i.e., after Tax Day. This caps out at 25 percent of unpaid taxes owed after five months.
5. Failure to Pay
In addition to a failure to file a penalty for late tax returns, a failure to pay penalty is levied on unpaid taxes that have not been paid by their due date, as per the IRS’ notices. The inability to pay the penalty is only 0.5 percent of unpaid taxes owed per month for up to 50 months. When added to the failure to file penalty, it reduces that penalty to 4.5 percent per month. After a full 50 months, a taxpayer will accumulate a total penalty of about 47.5 percent.
6. Failure to Deposit
A failure to deposit penalty is levied on taxpayers who failed to make their employment tax deposits or made erroneous deposits (i.e., not enough). Employment or payroll taxes include social security, employee income, and Medicare payments. These payments must be made monthly.
The penalty is applied based on how late the deposit is. Within the first five calendar days, the penalty is only two percent. But anything more than 15 days after the deposit was due is 10 percent. Ten days after the IRS sends a notice for immediate payment, the penalty rises to 15 percent.
7. Dishonored Checks
The IRS can penalize you for bouncing a check. For example, if you’re paying employment taxes but pay the wrong amount and have your check bounce, the IRS will levy a failure to deposit penalty in addition to a dishonored check penalty. Any payments below the threshold of $1,250 owe a penalty of the lesser of whatever bounced, or $25. Payments of $1,250 or more result in a penalty of two percent of the payment amount.
Key Takeaways About IRS Audit Penalties
In addition to levying penalties and additional interest, the IRS can coerce payment of unpaid taxes by issuing liens to limit financial freedom and levies to claim properties, investments, assets, bank accounts, and even incoming paychecks. If you’re in trouble with the IRS, don’t dawdle – get professional representation. The sooner you resolve your issue or contact the IRS to delay judgment, the softer the blow.