What Happens When You Fail an Audit?

An audit refers to a review of an individual’s or organization’s financial records by an authority, such as the Internal Revenue Service (IRS), to ensure compliance with tax laws and verify the accuracy of reported information. When an audit concludes with findings that indicate discrepancies, errors, or insufficient documentation, it can be described as “failing an audit.” This outcome leads to proposed changes to the tax return, which may result in additional tax obligations or a reduction in a previously expected refund. Subsequent steps involve formal communications, options for disputing results, and methods for resolving liabilities.

Receiving Audit Findings

After an audit, the auditing body, such as the IRS, communicates its findings through formal correspondence. This is often an examination report accompanied by a preliminary notice of deficiency, known as a “30-day letter.” This letter outlines proposed adjustments to the tax liability, explains reasons for these changes, and specifies the amount of any additional tax or obligation. It also provides a deadline, 30 days, within which the taxpayer must respond.

Common reasons for audit findings include undeclared income, such as unreported freelance earnings or investment gains, detected by the IRS through information matching programs. Disallowed deductions or tax credits also frequently lead to adjustments, often due to inadequate records or unmet eligibility criteria. Insufficient record-keeping is a recurring issue; taxpayers must maintain documentation for all reported income, expenses, and deductions.

Upon receiving an audit findings notice, carefully review all proposed changes and the explanations provided. The notice details which specific items on the tax return are adjusted and why. Understanding these proposed changes is the first step in determining the appropriate response.

Disputing Audit Findings

If a taxpayer disagrees with the audit findings, several steps are available to challenge proposed changes. The initial communication from the IRS, typically a 30-day letter, informs taxpayers of their right to appeal proposed adjustments. This letter includes the examination report detailing findings and the basis for liability. Taxpayers have 30 days from this letter’s date to respond and initiate appeals.

One option is to submit additional documentation supporting original tax return entries or clarifying discrepancies. This can be done by requesting a conference with the auditor to present new evidence or explain challenged items. If no agreement is reached, or if a more formal review is preferred, taxpayers can appeal to the IRS Office of Appeals. This independent office resolves tax disputes without litigation, considering facts and the likelihood of the IRS prevailing in court.

To initiate a formal appeal, a written protest must be filed, clearly stating contested changes and reasons for disagreement. For disputes involving proposed tax increases of $25,000 or less, a simpler small case request can be submitted. For amounts exceeding $25,000, taxpayers typically use IRS Form 12203, “Request for Appeals Review,” or submit a detailed written protest. This protest should include factual and legal arguments supporting the taxpayer’s position and must be signed under penalty of perjury. If no appeal is filed within the 30-day period, or if no agreement is reached, the IRS will issue a “90-day letter,” also known as a Notice of Deficiency, which then allows the taxpayer to petition the U.S. Tax Court.

Resolving Audit Liabilities

When audit findings are finalized, through agreement, unsuccessful appeal, or expiration of appeal periods, the determined additional tax or financial obligation becomes due. This final assessment includes additional tax, penalties, and interest. The IRS may impose penalties, such as an accuracy-related penalty, often 20% of the underpayment due to negligence, disregard of rules, or substantial income understatement. A substantial understatement occurs if the understated tax is more than 10% of the correct tax or $5,000, whichever is greater. A failure-to-pay penalty may also be applied, which is 0.5% of unpaid taxes per month, capped at 25%.

Interest accrues on unpaid tax, penalties, and interest from the original due date until the balance is paid. The IRS sets these interest rates quarterly; for individuals, the underpayment rate is the federal short-term rate plus three percentage points, compounded daily. For example, the underpayment rate for individuals for the first half of 2025 was 7%.

Several options exist for resolving outstanding liability. Full payment is the most straightforward method, stopping further penalties and interest. If immediate full payment is not feasible, taxpayers can request an installment agreement using Form 9465, allowing monthly payments, often up to 72 months. An Offer in Compromise (OIC) may be an option for taxpayers facing significant financial hardship, allowing settlement of tax debt for a lower amount if certain criteria are met.

Failure to resolve liability can lead to IRS collection actions. These measures include federal tax liens, which are legal claims against a taxpayer’s property (real estate, personal property, financial assets) to secure the tax debt. A tax lien becomes public record and can affect credit. If payment arrangements are not made, the IRS may proceed with a tax levy, involving legal seizure of property to satisfy the debt. This can include garnishing wages, levying bank accounts, or seizing other assets.