If the IRS audits your federal tax return and decides to make changes to it, you have effectively “failed” the audit. This can lead to an additional tax bill or a reduced refund, as well as audit penalties. However, depending on the situation, you may be able to dispute the audit results.
Key takeaways
- What is failing an audit? When the auditor makes changes to your tax return.
- If you disagree – Appeal the results within 30 days.
- If you agree – Request penalty abatement and make arrangements to pay the tax liability.
To help you understand the basics, this guide explains what happens when you fail an audit. Then, it outlines options for different situations. To get guidance and audit representation now, contact us at Damiens Law today. We customize our services to meet the unique needs of each of our clients, and we can help you find the best result possible for your situation.
What Happens When the IRS Changes Your Return During an Audit?
If the IRS proposes changes to your return at the end of an audit, the agency will send you a letter outlining the changes. The notice will show the original information from your return and the updated information. You can accept the changes and make arrangements to pay your tax bill plus penalties. Or you can dispute the findings.
What is an audit determination letter?
An audit determination letter is the notice that the auditor sends you at the conclusion of the audit, showing the proposed changes to your tax return.
What is a no-change audit?
A no-change audit is when the auditor agrees to your return as filed, and they do not make any changes. This may be referred to as “passing the audit”.
What are the two types of failed audits?
If the audit makes changes to your return, you can agree or disagree. An agreed audit is when you agree with the changes and you make payment arrangements. A disagreed audit is when you disagree with the changes so you dispute or appeal them.
How to Dispute or Appeal Tax Audit Results
To dispute the audit findings, you can request a managerial review. Requesting a review will allow you to meet with the IRS employee who audited your return and an appeals officer trained in mediation techniques. During the meeting, you can explain your side of the story, and the appeals officer will try to help you come to a resolution. This is also called Alternative Dispute Resolution (ADR). If you disagree with the ADR, you can appeal.
Alternatively, you can skip the ADR and file an appeal. To appeal the audit findings, you must send a written protest to the address on the audit results notice, and you must do so by the date on the notice. Typically, you have 30 days to appeal.
You can represent yourself during an appeal, but for the best results, you should work with someone who has a strong knowledge of the tax code and the appeals process. The IRS allows CPAs, tax attorneys, and enrolled agents to represent taxpayers during appeals hearings. If you go to Tax Court, you will need an attorney or a US Tax Court Practitioner (CPA or EA who’s passed a test to practice in Tax Court).
What If You Owe Additional Taxes After an Audit?
If you owe money and you don’t want to dispute the audit, you are legally obligated to pay the unpaid taxes plus penalties. If you can’t afford to pay in full, here are the main options. Check out the links to learn more:
- Payment plan — The IRS allows qualifying taxpayers to take up to six years to pay back taxes. You can get longer if you prove that it’s financially imperative.
- Offer in compromise — If you prove that you can’t afford to pay in full or make monthly payments, the IRS may let you settle for less than you owe.
- Partial payment installment agreement — The IRS lets you make payments on a settlement, but if your financial situation improves, you may have to pay the full balance.
- Currently not collectible — You submit a financial statement showing that you can’t pay, and the IRS stops collection actions against you.
- Bankruptcy — This option should only be used in extreme situations, and you should consult with a bankruptcy attorney because only some tax debts can be discharged. Generally, tax debt that was just assessed during an audit is not dischargeable in bankruptcy.
You should also apply for penalty abatement to reduce your balance owed. Getting relief from audit penalties, unfortunately, can be difficult. The IRS takes these penalties very seriously, and to increase your chances of success, you should work with a tax professional.
What If You Fail an Audit Due to Your Spouse?
The IRS offers innocent spouse relief to help people who incur tax debts due exclusively to their spouse, ex-spouse, or late spouse’s actions. To qualify, you must prove that you didn’t know about the understated tax and had no reason to know. When you apply, the IRS will ask you about your involvement with family finances and your knowledge of finances in general.
If you get accepted, the IRS will separate the liabilities on the tax return. Then, you will only be responsible for the tax related to your income, and your spouse or former spouse will be responsible for the remaining portion of the tax bill.
There are a few different types of innocent spouse relief, and they all have different rules.
IRS Tax Audit Penalties
Failing an audit can lead to a variety of penalties. When the IRS discovers that someone has filed an erroneous tax return, it assesses very high penalties. The IRS designs penalties to deter people from filing returns with false information.
Note that these penalties are hard to get waived. If you’re reading this before undergoing an audit, consider contacting a tax attorney today. They can often help reduce the scope and consequences of the audit.
Accuracy-Related Audit Penalties
If the IRS audit reveals that you have not followed the tax laws, you can incur an accuracy-related penalty which is 20% of the understated tax. For instance, if you filed your tax return so that it showed you owed $10,000 less than you do, the accuracy-related penalty will be $2,000.
This penalty applies if you’re negligent about following the rules or if you disregard the IRS’s rules by taking a position that is inconsistent with tax regulations. It also applies if you do any of the following:
- Understate your income by the greater of $5,000 or 10%
- Substantially overvalue donated property to increase a charitable deduction.
- Undervalue property on an estate or gift tax return.
If you don’t pay the penalties in 21 days or less, interest will begin to accrue on them.
Failure-to-File Audit Penalties
If the IRS determines that you filed late without an extension, you will also incur failure-to-file penalties. These are normally 5% every month that you are late, up to 25% of your tax due.
However, if the IRS determines that you filed late in an attempt to evade taxes, the penalties will be 15% of the tax due. These penalties can get up to 75% of your balance, but they’re relatively rare.
Penalty for Erroneous Credit Claim
The IRS also assesses a 20% penalty when an auditor discovers that you mistakenly or fraudulently claimed credits on your tax return. For instance, if you falsely claimed a $5,000 credit, you will incur a $1,000 penalty. Of course, your return will also be adjusted, and you may owe additional tax on top of having to repay the credit and the penalty.
If the IRS believes that you negligently claimed an Earned Income Tax Credit (EITC) that you were not supposed to have, it can ban you from claiming this credit for two years. However, it’s important to note that independent reviews of these bans show that about 40% of them were unnecessary. If you’ve been banned from claiming the EITC, contact a tax professional. This credit is very valuable, and as of tax year 2024, it can be worth up to $7,830. Returns that claim an EITC are audited at a much higher rate than other returns.
In cases where the IRS believes that fraud was involved, it can stop you from claiming the credit for 10 years. This rule applies to the EITC, the child tax credit, the American Opportunity Tax Credit, and the Credit for Other Dependents.
FBAR and Foreign Financial Asset Penalties
If the auditor discovers that you did not report foreign bank accounts or other specified foreign assets, you may face significant penalties. The penalties for not filing an FBAR are $10,000 per year adjusted for inflation (as of Jan 2025, the penalty is $16,536) for non-willful violations or the greater of 50% of the account value or $100,000 for willful violations ($165,353 as of 2025).
Failing to file a FACTA to report specified foreign investments can lead to a penalty of $10,000 for not filing and $50,000 for not filing after receiving a notice.
Tax Evasion or Fraud Penalties
In cases of tax fraud, the penalty is 75% of the tax that wasn’t reported on the return. This is the highest and most severe civil penalty you can face due to a failed audit.
What Happens If You Are Audited and Found Guilty of Tax Fraud?
The IRS will assess a civil fraud penalty of 75% of the understated tax. For instance, if an audit discovers that you underreported your tax due by $100,000, the fraud penalty will be $75,000. You may also face criminal charges, but civil penalties are much more common than criminal charges.
Fraud penalties and accuracy-related penalties don’t stack. In some cases, the IRS may assess a fraud penalty to part of your understated tax and an accuracy-related penalty to another part of the tax bill.
For example, imagine that you understated the tax due on your return by $80,000. The IRS determines that $20,000 of the understatement is due to negligence and $60,000 is due to fraud. You will incur an accuracy-related penalty of $4,000 and a fraud penalty of $45,000.
Removing fraud penalties can be very difficult. If you’re facing these penalties, you should consult with a tax attorney.
Criminal Charges After an Audit
It’s possible to face criminal charges after an audit, but it is very rare. In a typical year, there are under 2,000 criminal charges for tax fraud, and just a few hundred people are sentenced to jail time. However, if you are facing criminal charges or worried about the risk, you should contact a tax attorney immediately.
Criminal tax evasion penalties are up to $100,000 for individuals and up to $500,000 for corporations. Jail time can be up to five years.
Additional Audits
You may face audits on your older tax returns if you fail an audit. Generally, the IRS only audits your tax returns from a single year. However, if the agency finds serious issues, it will start to look at your other returns. Typically, the agency can only go back three years when auditing returns, but if there are substantial issues with your tax return, the IRS may look at the last six years of returns.
Reasons You May Fail an IRS Audit
In general, you fail an audit if the IRS makes changes to your original return. Here are some of the main reasons that this happens:
- Unreported income — This may happen if the IRS receives income documents that you didn’t report on your return. For example, you may have not reported crypto transactions, income from a freelance job, or other income sources. An auditor may also discover unreported income if they request bank statements and see that you have numerous bank deposits that you haven’t reported as income.
- Disallowed expenses — This applies to business taxpayers. It typically comes up when someone overstates their business expenses or claims personal expenses as business expenses.
- Disallowed deductions — If you itemize your deductions and the IRS doesn’t agree with a deduction, that increases your taxable income and leads to a higher tax liability.
- Disallowed tax credits — This may happen if you didn’t meet the criteria to claim a tax credit. It can also happen if the audit increases your taxable income so that you are ineligible for the credit.
- Failure to report foreign accounts or assets – The agency doesn’t just look at your income. Auditors also make sure that you’re reporting foreign accounts or assets as required by law.
In some cases, you may fail an audit just because you don’t respond to IRS notices. When you don’t respond, the audit results become final. This is even true if the notices went to an old address and you never saw them.
FAQs About What Happens If You Get Audited and Fail
What if an audit leads to a bigger tax bill?
If you disagree with the changes, you can dispute them. If you agree with the increased tax liability, you should pay the bill in full or contact the IRS to make arrangements for your account. A tax professional can help you learn about payment options.
What if I fail an audit due to a tax preparer’s mistake?
You are still liable for the tax liability. However, you may be able to hold your tax preparer liable for the penalties and interest. This can be a complicated legal situation that requires help from an attorney.
Can you go to jail for failing an audit?
Jail time for tax issues is very rare, but it is possible. Prison sentences can only happen if the IRS charges you with criminal tax evasion. With most tax audits, the IRS only assesses civil fraud penalties.
What if an auditor finds a mistake on my return?
You will be responsible for the additional tax liability plus any tax audit penalties. However, you won’t face severe consequences for simply making a mistake on your return.
Get Help Dealing With an Audit
Regardless of where you are in the audit process, we can help you. When you contact us, we’ll start with a free consultation. Then, we’ll help you determine the best path forward.
Dealing with an IRS audit can be stressful and confusing, but it’s even worse when you fail the audit. We can help you dispute the audit findings, introduce evidence to support your side of the story, apply for relief on audit penalties, and figure out how to pay the taxes owed from an audit. Or, if needed, we can help you explore other solutions. To get help now, contact us at Damiens Law.
At Damiens, we don’t offer one-size-fits-all tax advice — we’re a boutique tax resolution firm dedicated to finding the best solution possible for each of our unique clients. We look forward to providing you with the personalized attention your case needs and deserves.
