Few phrases are more stressful for taxpayers than “You are under IRS examination.” An audit may start with a letter requesting additional documentation, but what if things don’t go your way? Failure in an IRS audit is not merely academic; it can entail tax assessments, accuracy related penalties, interest charges, and, in egregious cases, referral to the Department of Justice for criminal tax prosecution. Below we explain the practical and legal ramifications of “failing” an audit, the stages where you can still mitigate damage, and why professional representation often alters the outcome. If you have become the target of an IRS audit or believe that you are at risk for one, do not hesitate to contact an experienced IRS audit defense attorney.
Defining “Failure”
In everyday language, you “fail” an audit when the IRS disallows your deductions, increases your income, or otherwise adjusts your return in a way that results in a tax deficiency, and you either cannot or do not successfully contest those adjustments. It’s not a moral judgment; rather, it’s the IRS concluding you didn’t meet your burden of proof under Internal Revenue Code § 6001 and related regulations.
Immediate Financial Consequences
Tax Deficiency
The IRS will issue a “30-Day Letter” (or a “Revenue Agent Report”) itemizing proposed changes. If you do nothing, the Service next issues a statutory Notice of Deficiency, giving you 90 days to petition the U.S. Tax Court. Absent a timely petition, the assessment becomes final and collectible.
Accuracy-Related Penalties
Under § 6662, accuracy-related penalties generally equal 20 percent of the understated tax. If the IRS deems the underpayment “substantial” or the result of negligence, these penalties apply automatically unless you demonstrate reasonable cause. Generally all it takes is an assessment of $5,000 in an audit and we generally see the accuracy-related penalty applied.
Civil Fraud Penalties
Where the Service believes you intentionally understated tax, it can assert the civil fraud penalty—75 percent of the underpayment under § 6663. The IRS must prove fraud by clear and convincing evidence, but once it thinks it can, the penalty is severe.
Interest Accrual
Interest on unpaid tax runs from the original due date of the return, regardless of extensions, at a rate tied to the federal short-term rate plus three percentage points. The longer the audit and subsequent appeals drag on, the larger your bill becomes.
Collection Actions
Once the assessment is final, the IRS proceeds with collection:
Liens
A Notice of Federal Tax Lien secures the government’s interest in your property, damaging credit ratings and jeopardizing financing opportunities.
Levies
If you don’t voluntarily pay, the Service can garnish wages, seize bank funds, and, in extreme cases, auction real or personal property.
Passport Restrictions
Under § 7345, seriously delinquent tax debt can prompt the State Department to deny or revoke your passport.
Potential Criminal Exposure
A civil audit can morph into a criminal tax inquiry if an examiner detects badges of fraud—false invoices, double sets of books, or willfully unreported income. In such cases, the examiner suspends the audit and refers the file to the IRS Criminal Investigation division (CI). CI agents have badges and the power to recommend prosecution. Convictions for tax evasion (§ 7201) or filing false returns (§ 7206) carry potential prison sentences, fines, and restitution.
Opportunities to Mitigate
During the Audit
Provide organized records, but only those requested. If you need more time, request it in writing. Auditors appreciate transparency and may reduce proposed penalties for cooperative taxpayers.
Appeals Division
If you disagree with the Revenue Agent Report, you can file a protest with the IRS Independent Office of Appeals. Appeals officers are separate from examination and have settlement authority. Presenting a well-documented position here often saves months of litigation.
Tax Court
Filing a petition within 90 days of the Notice of Deficiency halts IRS collection. The Tax Court allows you to dispute liability without paying first. Many cases settle before trial, but having legal representation is crucial because procedural missteps can forfeit rights.
Alternative Collection Arrangements
Even after assessment, you can negotiate an installment agreement, request currently-not-collectible status, or submit an Offer in Compromise. Each option has eligibility thresholds and paperwork requirements.
Role of a dual licensed Tax Attorney-CPA
Combining legal privilege with accounting acumen, a dually licensed professional can evaluate whether the IRS met its burden of proof on penalties, confirm that exam adjustments are mathematically correct, frame arguments grounded in statutes, regulations, and caselaw for Appeals or Tax Court, negotiate penalty abatements or collection alternatives, and shield sensitive communications under attorney–client privilege.
Long-Term Costs of Doing Nothing
Ignoring an adverse audit result rarely works. Unpaid assessments can become decades-long burdens because the IRS generally has ten years to collect but may extend that period indefinitely by reducing the amounts owed to judgment. Moreover, outstanding federal tax liens complicate real-estate transactions, business expansions, and even professional licensing renewals.
Failing an IRS audit is not the end of the story, but it is a turning point that demands deliberate action. In the world of taxes due, time is your enemy. Interest accrues daily, penalties mount, and collection apparatus gears up quickly. The sooner you seek professional help, the better your chances of limiting damage.
If you are facing an IRS audit, or have received a Notice of Deficiency, contact the Tax Law Offices of David W. Klasing today. Our team will analyze your case, protect your rights, and pursue the most strategic path to resolution before matters escalate.
