What Are the Consequences of Failing an IRS Audit?
Facing an IRS audit can feel overwhelming, especially when it’s your personal or business’ financial future on the line. I receive a lot of questions from business owners and taxpayers asking me what happens if they fail an IRS audit in California. It’s common to worry about consequences and penalties; but let’s look at what it really means to “fail” an IRS audit and what it may mean for your San Francisco business.
“Failing” an IRS audit is not the earth-shattering event that many may think. Generally, failing an audit means the IRS has determined you owe additional taxes due to errors, misreporting or underreporting on your tax return. Unlike what you may be thinking, failing does not necessarily imply intentional wrongdoing. It’s simply that mistakes, lack of documentation or misunderstanding tax laws can lead to unfavorable audit results.
The IRS determines your audit results are not favorable, you will likely face the following consequences.
- Payment of Additional Taxes — If the audit uncovers unreported income or deductions that are not allowed, you will be required to pay the additional taxes owed. The IRS will provide a detailed explanation, including how they calculated the amount due.
- Penalties — There are three types of penalties taxpayers can face. First, the Accuracy-Related Penalty occurs if the IRS determines there was a substantial understatement of your income or negligence. If that is assessed, you may face a penalty of up to 20 percent of the underpaid tax. The Fraud Penalty is given if the IRS determines you committed fraud on your taxes. That penalty can be as high as 75 percent of the underpaid tax. Finally, the Failure-to-Pay Penalty is assessed if you do not pay the taxes owed by the deadline. The IRS may impose a penalty of 0.5 – 25 percent of the unpaid taxes per month.
- Interest on Unpaid Taxes — The IRS charges interest on any unpaid tax from the original due date of the return until the balance is paid in full. This interest accrues daily, adding to the total amount owed.
- Consequences for California Taxpayers — The Franchise Tax Board (FTB) closely follows IRS audit results. If the IRS adjusts your federal tax return, the FTB may automatically reassess your California state tax return as well. That can also potentially lead to additional state taxes, penalties and interest.
- Criminal Investigation — Criminal charges are rare. However, if the audit uncovers deliberate tax evasion or fraud, the IRS could refer your case to the Criminal Investigation Division (CID). Conviction for tax fraud can lead to severe penalties, including imprisonment
If you do end up failing your audit, be sure to review the audit report carefully and note the IRS’ findings and calculations. If you disagree with the conclusions, you have the right to appeal through the IRS Office of Appeals, which provides an independent review of audit findings. If you cannot pay the full amount owed, the IRS offers payment plans, including installment agreements or sometimes an Offer in Compromise (OIC).
Failing an IRS audit in California is not the end of the world or your business. As always, always consult with an experienced San Francisco tax attorney or professional who can review your audit findings and work on your behalf with the IRS.
Allison Soares is a partner and tax attorney at Vanst Law LLP. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits from San Francisco to San Diego.
