What Happens If You Fail a Tax Audit?

When a tax audit concludes with the Internal Revenue Service (IRS) determining that additional tax is owed, it is often described as “failing” the audit. This outcome signifies that the IRS has identified discrepancies in a tax return, leading to an adjusted tax liability. Such a situation does not typically imply criminal charges, which are reserved for cases of deliberate tax evasion or fraud. Instead, it means the taxpayer faces an increased tax bill, along with potential penalties and accruing interest.

Understanding the Audit Findings

Following an audit where additional tax is deemed due, the IRS communicates its findings to the taxpayer. This communication includes a 30-day letter, outlining proposed adjustments to the tax return and informing the taxpayer of their response options. If the taxpayer does not reach an agreement or respond within the specified timeframe, the IRS issues a Notice of Deficiency, known as a 90-day letter.

The audit findings detail the additional tax liability, the primary adjustment to the original tax amount. The IRS also assesses various penalties and interest. Common penalties include the accuracy-related penalty, under Internal Revenue Code Section 6662, which can be 20% of the underpayment. This penalty applies if the underpayment results from negligence, disregard of rules, or a substantial understatement of income tax. A 40% penalty can apply for gross valuation misstatements.

The IRS also assesses a failure-to-file penalty under Internal Revenue Code Section 6651 if a tax return is not submitted by its due date. This penalty is 5% of the unpaid tax for each month or part of a month the return is late, capped at 25% of the unpaid tax. A minimum penalty may apply if the return is more than 60 days late.

A failure-to-pay penalty is assessed when taxes are not paid by the due date. This penalty is 0.5% of the unpaid tax for each month or part of a month it remains unpaid, capped at 25%. If both failure-to-file and failure-to-pay penalties apply in the same month, the failure-to-file penalty is reduced by the failure-to-pay penalty amount.

Interest also accrues on underpayments from the original due date until the full amount is paid. This interest is calculated under Internal Revenue Code Section 6601 at a variable rate. Interest continues to accumulate regardless of extensions granted for filing a return.

Responding to the Audit Findings

Upon receiving audit findings, a taxpayer has options for response. If the taxpayer concurs with the IRS’s adjustments, the process involves signing an agreement form, typically Form 870. Signing this form allows the IRS to immediately assess and collect the agreed-upon deficiency, including any associated penalties and interest. This action also waives the taxpayer’s right to challenge the adjustments in U.S. Tax Court for those specific tax years.

Payment of the agreed-upon amount can be made through various methods. The IRS offers electronic options like IRS Direct Pay for direct payments from a checking or savings account. Taxpayers can also use the Electronic Federal Tax Payment System (EFTPS), which requires enrollment for scheduling payments in advance. Payments can also be made by check or money order through traditional mail.

If a taxpayer disagrees with the audit findings, they have the right to appeal the decision. The first step, particularly after receiving a 30-day letter, is to submit a formal written protest to the IRS Appeals Office. A protest is generally required for proposed tax increases exceeding certain thresholds. The protest letter must include:

The taxpayer’s name and address
A statement requesting an appeal
A copy of the IRS letter detailing the proposed changes
The tax periods involved
A list of disputed items
The reasons for disagreement
Supporting facts
Any relevant legal authority

This document must also be signed under penalties of perjury.

An Appeals conference with an Appeals Officer is an informal proceeding where the taxpayer can present their case and attempt to reach a settlement. The Appeals Office operates independently of the IRS examination function and can consider litigation hazards when evaluating settlement proposals.

If an agreement is not reached at the Appeals level, or if the taxpayer chooses to bypass Appeals, the next step is to petition the U.S. Tax Court. This petition must be filed within 90 days of the date on the Notice of Deficiency. For smaller disputes, taxpayers can elect to use the U.S. Tax Court’s small tax case procedures. These cases are more informal, and the decisions are not appealable. A filing fee is required when petitioning the Tax Court.

Navigating Tax Collection Measures

Once a determined tax liability, including penalties and interest, remains unpaid after the audit and any appeal processes, the IRS initiates collection efforts. The collection process begins with a series of notices and demands for payment, escalating over time. If payment is not made, the IRS has several mechanisms to collect the outstanding debt.

Taxpayers unable to pay their full tax debt have options to resolve the liability. One common option is an Installment Agreement, allowing monthly payments for up to 72 months. Taxpayers typically use Form 9465 to request an installment agreement.

Those owing a certain amount in combined tax, penalties, and interest can often apply online. While an installment agreement is in effect, penalties and interest continue to accrue on the unpaid balance, though the failure-to-pay penalty is often reduced. A setup fee is associated with establishing an installment agreement, varying by payment method.

Another option is an Offer in Compromise (OIC), allowing certain taxpayers to settle their tax debt for a lower amount than owed. An OIC is considered when there is doubt as to collectibility (the taxpayer cannot pay the full amount), doubt as to liability (uncertainty about whether the assessed tax is correct), or when collecting the full amount would create economic hardship (effective tax administration).

To apply for an OIC, individuals typically submit Form 656 along with Form 433-A. Businesses submit Form 433-B. These forms require detailed financial information. An application fee and an initial payment are usually required with the OIC submission, though these may be waived for low-income taxpayers. Taxpayers must be current with all tax filings and estimated tax payments to qualify for an OIC.

If a tax debt remains unresolved, the IRS can take enforcement actions. A Federal Tax Lien is a legal claim the government has against a taxpayer’s property when a tax debt is neglected or unpaid. This lien attaches to all current and future property. While federal tax liens no longer appear on major credit reports, they are public records, which can still affect a taxpayer’s ability to obtain credit, secure loans, or sell assets. The IRS typically releases a lien within 30 days once the tax, penalties, and interest are paid in full.

An IRS Levy is a more direct enforcement action, allowing the legal seizure of property to satisfy a tax debt. This can include wage garnishments, where a portion of a taxpayer’s paycheck is taken directly. The IRS can also levy bank accounts, seizing funds present in the account at the time the levy is executed. Other assets can also be subject to an IRS levy. The IRS usually sends a Final Notice of Intent to Levy and Notice of Your Right to a Hearing before initiating a levy.