What Happens If You Get Audited and Fail?

An IRS audit examines a taxpayer’s financial records to verify the accuracy of a tax return. An unfavorable audit outcome means the Internal Revenue Service has identified discrepancies, proposing additional tax, penalties, or interest, or disallowing certain deductions or credits. Navigating this outcome requires understanding the communications received, financial obligations, and available resolution options.

Understanding an Unfavorable Audit Outcome

An unfavorable audit outcome occurs when the Internal Revenue Service proposes adjustments that increase a taxpayer’s tax liability. After an audit, the IRS communicates its findings through documents detailing proposed changes to the original tax return.

One communication is an audit report, often with a 30-day letter. This letter explains appeal rights and provides about 30 days to respond if the taxpayer disagrees.

If a taxpayer does not respond to the 30-day letter or cannot agree with the IRS, the agency may issue a Notice of Deficiency. This statutory notice, also known as a 90-day letter, formally notifies the taxpayer of the proposed tax increase and the right to petition the U.S. Tax Court within 90 days. These communications outline the IRS’s final determinations.

Financial Implications

An unfavorable audit outcome carries several financial consequences, including additional tax, penalties, and accrued interest. The most direct impact is the additional tax due, resulting from the IRS’s recalculation of tax liability based on adjustments to reported income, deductions, or credits. For instance, disallowing a business expense increases taxable income, leading to a higher tax obligation.

Beyond the additional tax, various penalties can significantly increase the total amount owed. Accuracy-related penalties, imposed under Internal Revenue Code Section 6662, apply for substantial understatement of income tax or negligence. These penalties are 20% of the underpayment attributable to the inaccuracy.

A failure to file penalty, under Section 6651, may apply if a return is filed late, at 5% of unpaid taxes per month, up to 25%. The failure to pay penalty, also under Section 6651, is assessed if taxes are not paid by the due date, at 0.5% of unpaid taxes per month, up to 25%.

In more severe cases, a civil fraud penalty, under Section 6663, can be assessed for intent to defraud, amounting to 75% of the underpayment. Interest also accrues on any underpayment from the original due date until paid, as specified in Section 6601. These interest rates are determined quarterly, based on the federal short-term rate plus three percentage points, compounding daily.

Disagreeing with the Outcome

When a taxpayer disagrees with an unfavorable audit outcome, several avenues are available to challenge the determination. The initial opportunity to respond arises with the 30-day letter, which provides a limited timeframe to request a conference with an IRS Appeals Officer. This step is a formal request for an independent review of the audit decision.

To initiate an appeal, a taxpayer can use Form 12203, Request for Appeals Review, or submit a written protest if the proposed additional tax exceeds $50,000. During an Appeals conference, the taxpayer or their representative engages in informal discussions and negotiations with an Appeals Officer.

The Appeals Office operates independently from the IRS examination function, aiming to resolve tax disputes fairly and impartially without litigation. The goal of the Appeals process is to facilitate a resolution based on the hazards of litigation, meaning the likelihood of success for either side if the case were to go to court.

If an agreement cannot be reached at the Appeals level, and a Notice of Deficiency has been issued, the taxpayer retains the option of petitioning the U.S. Tax Court. The Tax Court functions as an independent judicial body that hears disputes between taxpayers and the IRS, allowing for a formal legal review of the proposed tax liability.

Satisfying the Tax Obligation

Once an audit outcome is finalized, either through agreement with the Internal Revenue Service or after exhausting appeal options, the taxpayer will receive a bill detailing the amount due. This bill might come as a CP14 notice (balance due) or a CP504 notice (intent to levy).

Taxpayers have several methods to satisfy this obligation. Full payment can be made online through IRS Direct Pay, by mail with a check or money order, or over the phone using a debit or credit card.

If immediate full payment is not feasible, the IRS offers payment plans to manage the debt over time. One option is an Installment Agreement, applied for using Form 9465. This agreement allows taxpayers to make monthly payments for up to 72 months, though interest and penalties continue to accrue.

Another option for those experiencing significant financial hardship is an Offer in Compromise (OIC), submitted using Form 656. An OIC allows taxpayers to settle their tax liability for a lower amount than what is owed. The IRS may accept an OIC based on three primary reasons: doubt as to collectibility (the IRS believes the taxpayer cannot pay the full amount), doubt as to liability (there is a legitimate doubt that the assessed tax is correct), or effective tax administration (collecting the full amount would cause economic hardship or be unfair).

The OIC application process is complex and requires extensive financial disclosure. If no payment or payment arrangement is made, the IRS can pursue various collection actions to secure the outstanding debt. These actions include filing a Notice of Federal Tax Lien, a public claim against assets, or issuing a tax levy, which allows the IRS to seize property, bank accounts, or wages.