IRS Collections

How Taxpayers Loaned $192 Billion To The Government In 2013

Very few people enjoy paying taxes, and even fewer wish to overpay on their federal income tax returns. But 80 percent of taxpayers voluntarily do just that each year. Many of these same taxpayers celebrate when they receive large refund checks, failing to realize that they are merely recovering their own money.

According to an April 2014 article in the Washington Post, federal income tax over-payments by individual taxpayers totaled an eye-popping $192 billion last year. This figure represents the equivalent to one quarter of the entire federal budget deficit for 2013. By overpaying on their tax returns, taxpayers essentially provide the government with an annual 12-month interest free loan, a deal which the IRS does not reciprocate.

Regions with the Highest Rates of Income Tax Refunds

refundsThe regions with the highest rates of taxpayers receiving refunds are found in Appalachia and the Deep South. For instance, in Chattahoochee County, Georgia, an astonishing 95 percent of taxpayers received federal tax refunds during the previous year, according to the Post. It is no coincidence that these regions are also among the most impoverished in the country. Taxpayers in these regions of the country often have low or no federal tax obligation.

Many taxpayers in these areas also benefit from deductions and credits like the Earned Income Tax Credit (EITC), which is a refundable credit. Taxpayers who qualify for the EITC can receive some or all of the credits in the form of a tax refund check, even if they have no federal income tax obligation. The refunds of many low-income taxpayers in this region and elsewhere in the country are drawn from the EITC.

Areas with High Proportions of Taxpayers Owing Tax

dueAn additional 15 percent of taxpayers nationwide owed money to Uncle Sam, with an average tax obligation of $4,656, the Post reports. These taxpayers were largely concentrated in metropolitan areas on the East and West coasts, and in the Plains states. Many of these individuals were self employed entrepreneurs, ranchers and farmers, filing Schedule C, E or F along with their federal income tax returns.

New England and the Plains States

In Liberty County, Montana, only 38 percent of taxpayers received federal income tax refunds. Another 32 percent of taxpayers in Liberty County essentially broke even with Uncle Sam, neither receiving refunds nor owing additional federal income taxes. Liberty County is representative of the states in the upper Plains region, which featured a high concentration of break-even taxpayers. Other states with high numbers of break-even taxpayers include Michigan, Pennsylvania and Vermont, according to the Post.

Lending to Uncle Sam at Zero Interest

uncle_samIn 2012, the average tax refund was a whopping $2,742 according to the Post. And while many taxpayers enjoyed receiving those large checks, a broad consensus of financial experts agrees that it’s actually a bad financial deal. Taxpayers receive no interest on their refunds unless the IRS delays the processing of their refunds by at least 45 days after the filing date of their federal income tax returns. The amount of interest paid is adjusted quarterly. For 2014, the quarterly interest rate paid by the IRS on delayed tax refunds was a paltry 3 percent.

The IRS is not nearly so generous with taxpayers in arrears. Even if you file your return on time, if you don’t pay your full federal income tax obligation, the IRS tacks on a failure-to-pay penalty of ½ of 1 percent on the amount due EVERY MONTH or partial month after the filing due date. The total penalty can equal 25 percent of the amount owed. Taxpayers who request an automatic extension of time to file do not automatically escape the failure-to-pay penalty. These taxpayers must pay at least 90 percent of what they owe by the ORIGINAL due date to escape the penalty.

Neither a Borrower nor a Lender Be

moneyMost taxpayers understandably don’t want to owe money at tax time, so they hedge their bets by overpaying. While it’s a good idea to allow for a small cushion to cover income tax withholdings, the IRS also cuts taxpayers who honestly underestimate their tax obligations a bit of slack. You can escape what the IRS calls the underpayment of estimated tax if your total federal tax obligation is less than $1,000. You may also escape the penalty by paying 90 percent of the current year’s federal tax obligation or 100 percent of your tax obligation for the previous year, whichever is smaller. Wage earners can make adjustments in the withholdings listed on W4 forms. Self-employed workers can meet this obligation through quarterly estimated tax payments.

Many taxpayers enjoy receiving their refunds in a lump sum rather than as small additions to their paychecks. That’s understandable as well, but it’s not necessary to overpay Uncle Sam to achieve that goal. Simply divide your average tax return by the number of paychecks you receive. Open a savings account or money market account and deposit the resulting amount into your account with each paycheck. If you want, you can make periodic transfers from your account into a Certificate of Deposit or other investment instrument. At the end of the year, you will have accumulated a tidy sum that equals or exceeds what you would have received as a tax refund.

Why Am I Being Audited By The IRS?

Statistically, your odds of being audited by the IRS range somewhere between slim and none. Very few people actually receive those dreaded notices. But there are circumstances that can boost your odds of being audited considerably. In many cases, honesty is the best policy for avoiding an audit. But sometimes, there is little or nothing that you can do to reduce your odds.

Your Return Triggered an Audit Flag

red flag

You’ve probably seen at least one list of common “audit flags” to avoid. For instance, tax returns for people who are paid largely or entirely in cash, such as wait staff, are often flagged for audits. People who make large charitable contributions (and claim large charitable deductions) may also trigger an audit flag.

The problem is that many common audit flags are legitimate tax deductions or credits. For instance, if you are a consultant or entrepreneur with a legitimate home office, you’re entitled to claim the home office deduction. Likewise, if you are entitled to the Earned Income Tax Credit, it’s financially unwise to leave that money on the table.

You may not even realize that you have tripped an audit flag. For example, according to a 2013 report from the IRS Taxpayer Advocate Service, an astonishing 90 percent of tax returns for adoptive parents who claimed the adoption tax credit were flagged for review. Almost 70 percent of taxpayers claiming the adoption tax credit were subjected to at least a partial audit.
The take-home lesson here is that if your return stands out from the ordinary, you may very well trigger an inquiry from the IRS. But that’s no reason to skip out on legitimate tax breaks. Instead, maintain meticulous records so that you can justify your claims.

Someone Ratted You Out

Yes, it’s true, people really do turn in their spouses, friends and co-workers to the IRS, sometimes out of spite, but also from greed. The IRS Whistleblower-Informant Award pays informants up to 30 percent of all tax penalties and other funds collected as a result of provided tips. Even people who are involved in tax evasion schemes may collect rewards under the program. They must voluntarily provide information and their rewards may be reduced, but they still get paid.

Someone You Do Business With Was Audited

IRS audit

Do you do business with someone who has been audited? You may very well be next. At the very least the IRS may request clarification about your dealings with the person being audited. If your records are in order, you shouldn’t have any reason to worry.

You Filed Your Return Late (or Not at All)

Requesting an automatic extension for time to file your federal income tax return does not count as filing your return late, nor does requesting an extension trigger an audit flag, so relax. On the other hand, filing your return after April 15 without having requested an extension does make your return more likely to be flagged for an audit. If you fail to file a return, the IRS may file one for you – minus many tax breaks to which you may rightfully be entitled. If you file a late return, the IRS will hit you with a hefty penalty of 5 percent of the taxes that you owe every month for up to 5 months. Ouch.

You’re Really Rich


If you are a wage-earner who files a return with W-2 forms and reports income of less than $200,000, your chances of being audited in 2013 were a miniscule 0.4%, according to Forbes. During the same period, the IRS audited the tax returns of 1.2 percent of entrepreneurs and self-employed workers who earned less than $200,000. By contrast, the IRS tagged 12.1 percent of taxpayers with incomes over $1 million in 2013 and 17.1 percent of taxpayers with assets in excess of $10 million.

You Drew the Short Straw

The IRS selects a certain number of returns for audit strictly by random. But the recession and budget cuts have reduced the number of random audits in recent years. The number of random audits was likely further reduced during 2013 because of the sequester, according to Forbes.

Tax Tips: How to Prepare for an IRS Tax Audit

IRS audits are actually becoming less common these days, with the number of actual audits performed in 2012 dropping 5.3% compared to the year before. That trend is expected to continue due to budget cuts and new responsibilities that have been placed on the department, ultimately resulting in fewer IRS agents available to conduct examinations.

The number of IRS agents available to perform tax audits in 2014 is expected to be at its lowest number in over 3 decades.

Last year the Internal Revenue Service selected approximately 1,481,966 individual tax returns to audit, or roughly 1% of tax payers. While the mere mention of the words “tax audit” strikes fear in the lives of many, there is really nothing to worry about if you are chosen as one of the lucky few. Nothing to worry about as long as you are prepared and haven’t committed tax fraud, that is.

Find out why you were chosen to be audited

If you have been selected for an audit, that doesn’t necessarily mean that you have made an error on your tax return. Individual tax payers returns are selected using several different methods, including:

  • Random: Some returns are selected at random by a computer screening process, which can often involve a statistical formula that identifies returns that are out of the “normal” or “average” range.
  • Document Mismatch: Oftentimes the simplest slip of a finger while entering information on your return, could result in inaccurate information being submitted. This could include W-2 forms or 1099’s that are reported but don’t match the information provided.
  • Related/Partner Returns: Sometimes a return may be selected for audit when it includes transactions or other related issues with other taxpayers. This is usually found due to a business partners or investors return already being audited.

What type of audit are you facing?

There are actually 3 main types of audits that the IRS performs regularly. Depending on which type they have scheduled for you, it may end up being a fairly painless procedure for you. The IRS will always start the audit process by sending you a letter. This letter should tell you what kind of audit you are being scheduled for.

Correspondence audit (Form 566(CG)) This is by far the simplest form of an IRS audit. Usually a taxpayer will receive this type of an audit when they forgot something simple on their tax return (like a signature) or if more explanation is required of something more specific (like itemized deductions).

In-office audit(Form 3572) These types of audits are most commonly sent to people who are self-employed or who own small businesses. The taxpayer will be required to go to the local IRS office to explain certain things on their tax return. These types of audits can generally take several hours, but are usually resolved on the day of the visit.

Field audit (Form 4564) These are the audits where IRS Field Representatives will be sent to your home or your place of business to conduct the examination. That is usually because of the fact that there is too much information to send via mail or carry with you into the nearest office. These are by far the most comprehensive types of all the audits and can take multiple visits to resolve all of the issues involved.

Know Your Legal Requirements

There are many laws you should know with regard to the retention of your personal and business financial records. For example, all business records regarding any particular asset should be kept for as long as the asset is kept, plus three years. Payroll records need to be kept for all personnel for at least six past years plus the current year.

The IRS can include returns filed within the last three years when they perform an audit. They can also include additional years if a substantial error is found, but will generally not go back further than six years.

Gather the Necessary Documentation

Once you have identified the type of audit that is being performed, you can start preparing your supporting documents. The IRS will include in its letter to you any specific documentation that they will need to review during the examination.

The key to having all the documentation you need for an easy audit is to get in the habit of retaining all your documents in a clean and organized manner ahead of time. Every year when you file your return, you should maintain a file that includes any and all supporting documentation to go along with it.

Keep all of this information along with a copy of your W-2’s or 1099’s and a copy of the return you submitted with the IRS.

If you have not kept the tidiest of records for the year that is being examined, go through your return very carefully and try to recollect the information that got you to those figures originally. Once you have identified where the figures came from, you can try to find them again. For example, if you claimed a lot of medical expenses, you may have some luck by contacting the billing department of the hospital or Doctor’s office that treated you and requesting copies of your bills for that year.

Having to recreate records this way will certainly take you longer to collect, so make sure you start gathering all of your required documents as early as possible.

Organization = A Quick Audit

Keeping your records in a clean and simple manner is critical to a problem-free audit. If you have all of your supporting documentation in a well organized, professional manner when the IRS Field Agent comes knocking on your door, they will be able to get all the information they need to wrap up the examination quickly.

What if you’re not prepared?

If the date of your scheduled appointment with the IRS is soon approaching and you do not feel completely prepared, you can always try requesting more time. You should contact your auditor directly at the number that was provided in your notification letter to explain that you would like to postpone your appointment.

While the IRS agent is more than likely to want to work with you, it is important to remember that the sooner the audit begins, the sooner it can be over. It may be more beneficial to keep your original appointment and at least get the process going. You can then schedule a follow up appointment at a later date and time to submit any additional documentation that you were able to gather.

Obtain professional representation if needed

In any case, if you feel that you are in over your head or intimidated by the auditing process, it may be a wise idea to consult with a licensed tax professional. They can review your case information and all of the documentation that you are able to provide and better advise you on how to proceed in dealing with the IRS.

The most important thing is to remain calm and collected. The more organized you are, the better. And don’t forget to behave in your highest professional regard when dealing with the IRS agent directly. Your attitude and willingness to cooperate with their procedures will make the examination quicker and less painful for all involved.

Additional Tax Tips:

What Happens in an IRS Audit
What to do during an IRS Audit
How to survive an IRS tax audit

Are frequent flier miles or credit card points considered income by the IRS?

As a serial credit card churner, I am particularly interested in the IRS’s view on this matter, which is why I awaited with bated breath the United States Tax Court decision on the case between Parimal H. Shankar and the Commissioner of the Internal Revenue, back in August of 2014.

The issue in this case was whether Mr. Shankar had or hadn’t understated his income by $563 when he failed to report the Citibank points he used toward a trip. Mr. Shankar opened an account with Citibank and received some Citibank “Thank Your Points” as a reward. He then used those points toward the cost of a trip. The IRS argued that Mr. Shankar should have reported the savings from the ticket, the $563, as income.

The U.S. Tax Court decided in favor of the IRS. So does this mean all frequent flyer points should be declared as income? Thankfully no, the Tax Court was very careful about how it worded its decision and made it clear the decision was to have only a narrow application. The IRS sometimes considers frequent flyer miles and reward points as income, but not always. (U.S. Tax Court)

Welcome to the shady world of frequent flyer miles and credit card reward points. Hang in with me. We will get some clear answers by the end of the article.

So how does the IRS consider frequent flier miles or credit card points?

That is a good question. Are frequent fliers a prize, interest, a rebate or all of the above? The answer to that question largely determines whether they are a source of income and therefore taxable.

What has the IRS said on this subject in the past?

Nothing definitive or we wouldn’t be having this conversation, but a 2002 private letter ruling does provide insight on the IRS’s view on miles and points. The key section for our purposes says:

“ … the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.”

When I read that I gave a small sigh of relief. It didn’t last long. The next paragraph had this to say:

“This relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes.”

Another tidbit from the IRS’s collective psyche was revealed in IRS Publication 17 Other Income, which says under the section of Rewards:

“Rewards. If you receive a reward for providing information, include it in your income.”

Before the IRS vs Mr. Shankar case, the last time the taxation of frequent flyer points hit the media was in 2012, when it was reported that Citi had issued 1099-MISC tax forms to clients who had received reward miles for signing up for a new checking or saving account. At least two clients sued Citibank for not disclosing that information when they advertised the extra points. (LA Times)

So are miles or points taxable or not? 

The IRS is playing a wait-and-see game on this issue, so it’s impossible to be dogmatic. However, this much we can say from a careful analyzes of previous decisions, comments and rulings.

The Bottom Line: Rebate vs Interest

As indicated by the Tax Court decision on Mr. Shankar’s case, mentioned above, if you received the points or miles as a bonus for opening a bank account and making a deposit, the IRS could consider it as income.

This is because you are receiving the rewards in exchange for what amounts to “lending” money to the bank, which is interest and therefore a taxable source of income. Also, you didn’t buy anything to qualify for the bonus, so it can’t be considered a rebate.

To illustrate, last month Chase bank offered me $200 for opening an account and leaving my money with them for 6 months. There were no other strings attached so I was happy to transfer my emergency fund to another bank for $200. However, I know I’m going to have to declare the $200 as income.

The same would apply if I received 50,000 points or miles for opening an account. The only problem with points is that their cash value is not always easy to calculate. A ballpark ratio that often works is one cent per mile/reward point, but a lot depends on the rewards program and how you decide to spend your points.

Now the good news.

The IRS considers points you receive from using a credit card as a rebate. Sure, it may feel like free money when you get a signup bonus of $500 to spend on travel expenses, but you probably had to spend $2,000 to $3,000 in three months to receive the bonus. Technically, it’s a rebate.

As long as you had to make some kind of purchase or financial transaction to receive the points or miles, the IRS considers it as a price reduction not interest. This doesn’t mean things couldn’t change in the future, but right now, fellow credit card-churners, we are in the clear.

There is one caveat. The IRS will not allow you deduct a business expense you paid with frequent flyer miles or reward points. For instance, let’s stay you are the owner of a company and you declare the cost of plane tickets on a business trip but you pay for the tickets with points or frequent flyer miles. The IRS considers this as double dipping. If you use miles or points to pay for expenses and then declare the full cost as a deductible expense, you could get into trouble with the IRS.

Learn more about tax deductions for business travel in this article.

How You Are Notified of an IRS Audit

If audited, individuals can face financial burdens that last for years. Understanding how the IRS notifies people being audited is one way to be prepared for this unfortunate situation.
When the IRS audits a person, he or she is sent a letter by the mail or with a telephone call. Email notifications are not how the IRS notifies people about an audit and should be reported.

Related article: Dealing with an IRS Audit – 10 Expert Tips

Generally those who are audited fall into some common categories:

  • Being wealthy – 12.5% of those who make over one million dollars a year are audited. The IRS is diligent in checking that these individuals are reporting their income correctly.
  • Making mistakes – These mistakes are generally failure to report all income, mismatched or transposed numbers from the employer’s W2, or incorrect calculations like rounding errors.
  • Self-Employed – The IRS checks the deductions of a self-employed individual and compares them to others who work in the same industry. Records concerning home offices should be kept in case.
  • Making large donations to charities – The IRS compares the amount of income and donations to see if they are mutually agreeable.
  • Business partners and family members being audited.

There are three types of audits that the IRS conducts.

A correspondence audit is more common and done entirely by mail. They will have a form that an individual will fill out. It will ask common questions about income, expenses, and itemized deductions.

A field audit is when an IRS agent visits an individual at the home or business. This audit typically requires in depth record keeping as the IRS will want to inspect them and make sure they match the numbers reported.

An office audit is when the IRS requests a person to take records and paperwork to the closest office. This is done as a formal way to inspect records and paperwork without needing to send a field agent to your home or business.

If a person is being audited, it is imperative to respond to the IRS letters by the deadline given on the notices. The IRS may consider an extension during this time, but they are far less likely to be so considerate once the time period has passed.

It’s also important for a person being audited to have copies of documents and records at the ready. Having copies means that the originals aren’t lost or destroyed during the audit process. We also recommended, if you’re being audited, to be represented by a tax attorney or CPA for protection.

Receiving an audit letter or phone call is stressful, but understanding how the process works can help make it a smoother transition back to normal.

US Cracks Down on Corporate Inversion

Walgreens threatened to do it but backed down after intense negative publicity. Burger King is moving ahead with its own plans to do it despite the threat of backlash from angry consumers. And until recently, it appeared that the United States government was not in a position to do anything at all to prevent it.

Related article: Corporate Tax Inversion: The Tax Strategy That’s Losing the IRS Big Bucks

“It” is the practice of corporate inversion: the merger of an American corporation with a foreign company. Such mergers are made to facilitate a move to the country where the foreign company is located, allowing the American company to duck the 35 percent corporate income tax rate imposed by the IRS.

It’s estimated that corporate inversions could cost the IRS more than $20 billion in tax revenues from 2015 through 2024. But with the present hyperpartisan state of Congress, it appeared that no action would be taken to address the issue before the November 2014 midterm elections.

Closing the Borders

That was before the Treasury Department decided to step in on its own. Treasury Secretary Jacob J. Lew announced on September 22 that the department was taking independent action to clamp down on corporate tax inversions. In his announcement, Lew stated that the Treasury department is continuing to explore its options to curb corporate tax inversions. (

Specifically, Lew announced that going forward, so-called “hopscotch” loans would be prohibited from firms engaging in corporate inversions. “Hopscotch” loans allow US companies to skim their dividend tax obligations by “borrowing” profits made from controlled foreign corporations (CFCs) rather than declaring them as taxable dividends paid to the U.S. parent firm. Before the change in the regulations, such loans were not considered to be American funds – and were therefore not taxed.

The new regulations also cracked down on the practice of de-controlling, which allows foreign companies acquired by corporate tax inversions to avoid ever paying US taxes on the American company’s deferred earnings. In de-controlling, the newly acquired foreign parent company purchases enough of the CFC’s stock to gain control, allowing it to remain a foreign company and immune from American corporate taxes.

Now such transactions would be treated as a transfer of stock to the new foreign parent company from the former American parent company rather than the CFC, whose profits and deferred earnings would remain taxable by the IRS.

Lew also announced strategies to remove the financial incentives for two other strategies employed by companies engaging in corporate tax inversions: spin versions and skinnying down. With spin versions, American companies spin off entire units to foreign acquisitions. Skinnying down, which involves a company’s reducing its size before a merger through paying out special dividends, is also prohibited.

Reversing Course

These new regulations represent a reversal from the position expressed by Lew in July, when he stated that he did not believe the Treasury Department had the authority to stem corporate tax inversions on its own. It is possible that Lew was influenced by legal arguments made by Stephen Shay, professor of practice at Harvard Law School. Shay urged the secretary to take action against corporate tax inversions in an article published by Tax Notes in July. (Tax Analysts)

On the same day that Lew announced the new regulations, Tax Anaylists published an article by Steven Rosenthal, a senior fellow at the Urban-Brookings Tax policy center that supported the move. Rosenthal’s article states that Section 385(a), enacted in 1969 and expanded in scope by Congress in 1989, allows the Treasury department to designate certain obligations of an American company to a foreign affiliate as stock (which is subject to federal taxation) rather than debt (which is not). In other words, the Treasury department is on solid legal ground in its prohibition of “hopscotch” loans and other anti-inversion regulations. (Tax Analysts)

The Uncertain Future

Despite the actions taken by the Treasury Department, the Obama administration has expressed its preference to work with Congress to craft a collaborative approach to the problem. But an anti-inversion bill introduced by Democrats over the summer stalled in Congress. For their part, Republicans are seeking an overhaul in the entire corporate tax code and a lower corporate tax rate. Democrats also want to reform the corporate tax code – but with an emphasis on closing corporate tax loopholes.

IRS Tax Audit Penalties: What You Should Know

If you have been summoned for an audit by the IRS, you should know that the odds of escaping without owing additional taxes are slim. In general, the IRS does not spend its resources on conducting tax audits unless there is a good chance for significant revenue to be gained.

What you may not be aware of is that, if you owe more, along with extra taxes, you will likely be assessed penalties of some type. The amount and severity of the tax audit penalties that you face are directly related to the type of deficiency the audit uncovered. But you also have the opportunity to soften the blow or perhaps even have the penalties removed.

Accuracy Related Tax Penalties

If an IRS audit finds that you filed a substantially inaccurate return, you could be facing accuracy related penalties of 20 percent of the amount you underpaid. In extreme cases, the penalty charged could be doubled to a whopping 40 percent of your total tax underpayment. The following list indicates the types of accuracy related penalties that may result from a tax audit. (About Money)

  • Negligence or Disregard of Regulations. Failure to make a reasonable attempt to adhere to Federal tax code rules, such as failing to file a tax return at all
  • Disregarding IRS Rules or Regulations. Positions taken on tax returns that are substantively inconsistent with IRS regulations
  • Substantially Understating Your Taxes. Understating your income by $5,000 or 10 percent, whichever is greater.
  • Substantially Misstating the Value of Property. Overvaluing of donated property or undervaluing of depreciating property by 200 percent carries a 20 percent penalty. Overvaluing donated property or undervaluing depreciating property by 400 percent carries a 40 percent penalty
  • Substantially Overstating Pension Liabilities. Overstatement of pension liabilities by at least 200 percent carries a 20 percent penalty; overstatement of pension liabilities by 400 percent carries a 40 percent penalty. No penalty will be applied if the overstatement is $1,000 or less
  • Substantially Understating a Gift or Estate. Erroneously stating the value of property claimed on a gift tax or estate tax return at 65 percent or less of its actual market value carries a 20 percent penalty. Erroneously stating the value of property claimed on a gift tax or estate tax return at 40 percent or less of its actual market value carries a 40 percent penalty. No penalty will result if the understatement results in a tax underpayment of $5,000 or less.
  • Understatements Related to Reportable Transactions. 20 percent penalty for understating tax liabilities due to a tax shelter or tax avoidance transaction that are disclosed. Inadequately disclosed tax shelters or tax avoidance shelters that carry a 30 percent penalty.

Penalties for Failure to File Returns and Pay Taxes

If you are late in filing your tax return or paying your taxes, the penalty is 5 percent of the unpaid tax, charged each month, up to a maximum of 25 percent. A minimum penalty of $135 can be charged for returns filed more than 60 days late. Filing your return on time but paying late carries a lighter penalty of 0.5 percent of the tax you owe each month up to 25 percent. If you are charged for both penalties for the same month, the penalty for failure to file is reduced to 4.5 percent. (

If you fail to pay up on taxes owed after an audit, the IRS will assess a penalty of 0.5 percent for each month the tax is not paid. The clock starts ticking 21 days after the IRS issues the notice. If you pay the amount owed in full within 21 days, you will not be charged an additional penalty.

To add insult to injury, if an audit results in accuracy related penalties, fraudulent failure to file a tax return or civil fraud, the IRS adds interest of 3 percent annually to the amount of your penalty. If the penalty is $100,000 or less, you have 21 days to pay in full before interest is added. If the penalty is more than $100,000, you only have 10 days to pay up before the IRS begins adding interest.

Civil Fraud Penalty

If an IRS audit results in a charge of civil fraud, you won’t wind up in jail. But the IRS slaps a hefty 75 percent penalty on any tax underpayment that resulted from fraudulent activity.

There is one sliver of a silver lining to this financially dark cloud — accuracy related penalties cannot be applied to taxes owed as a result of civil fraud. In other words, you can’t be penalized on top of a penalty.

Fraudulent Failure to File a Tax Return

If you mistakenly believe that you were not obliged to file a tax return and the IRS catches up with you through an audit, you’ll be hit with penalties for failure to file and failure to pay, but you won’t be charged with fraudulent failure to file a tax return.

Instead, fraudulent failure to file a tax return refers to a deliberate failure to file a return, and can be either a civil or misdemeanor criminal offense, although civil charges are much more common. If criminal charges are filed, you could be sentenced to up to a year in jail plus $25,000 in fines for each year that you fail to file. The statute of limitations for criminal charges is six years; there is no statute of limitation for civil charges.

Willful Failure to Pay Estimated Taxes or Keep Records

Willful failure to pay estimated taxes or maintain tax records is considered to be a misdemeanor by the IRS. Just as with fraudulent failure to file a tax return, civil rather than criminal penalties are applied most often for this type of infraction. If the IRS brings criminal charges against you, as the result of an audit or criminal investigation, you could face up to a year in jail and $25,000 in fines for each year for which you are charged.

Filing a Fraudulent Return

Many tax protesters, including actor Wesley Snipes and singer Lauryn Hill, have found themselves on the wrong side of the law because they filed frivolous returns based on claims that income taxes are unconstitutional. Filing a fraudulent tax return is considered a felony, but less serious than tax evasion. If you are convicted of filing a fraudulent return as a result of an audit or as a result of IRS investigation, you could face up to 3 years in prison and up to $100,000 in fines. (

Tax Evasion

Tax evasion has snared some of the most notorious figures in history, including Chicago crime syndicate boss Al Capone. The IRS defines tax evasion as the willful concealment or misrepresentation of financial resources and assets to avoid paying taxes. If an IRS audit or criminal investigation results in a tax evasion conviction, you could be facing up to 5 years in prison and up to $100,000 in fines.

Audit Reconsideration

If worse comes to worse and you are nailed with more taxes and penalties as the result of an audit, but you disagree with the result, you can request an audit reconsideration. You must request it before you pay any taxes, penalties or interest that you intend to dispute, not after. If you have already paid the taxes, penalty and interest, you must request a refund. Submit the following documentation to the same office that conducted your audit. (Journal of Accountancy)

  • Statement explaining your reasons for requesting an audit reconsideration
  • Form 1099, cancelled checks, bank statements and similar new documentation
  • Copies of previously supplied materials
  • Copies of correspondence from the IRS

The IRS is not obligated to grant your request. But if you can demonstrate any of the following circumstances, your request for audit reconsideration should be approved.

  • You did not appear for the audit
  • You moved and did not receive proper notice for the audit
  • You submitted documentation that the IRS refused to consider that would reduce or eliminate the taxes, penalties or interest you owe
  • You have new documentation to support your case
  • You file a return that shows the correct tax to replace a return created by the IRS because you previously failed to file a return
  • The IRS committed math or processing errors in calculating the tax you owe

The IRS should respond to your request for an audit reconsideration within 30 days, although the wait could be longer. Bear in mind that penalties and interest continue to accumulate during that time. If you are suffering financial hardship due to delays in processing your audit return, you can ask for your request to be expedited.

Offer in Compromise and Penalty Abatement

If your request for audit reconsideration is denied, you may still be able to ease your burden. If you cannot pay the full amount of tax that you owe, you may request an Offer in Compromise, which settles your tax obligation for a fraction of what you actually owe. Be forewarned that the IRS accepts only a small percentage of Offers in Compromise. Obtaining expert advice from the experts at Optima Tax Relief will improve your odds.

Under certain circumstances you may request a penalty abatement, which results in some or all the penalties you have been charged being waived. The IRS generally approves requests for penalty abatement based on reasonable cause or administrative waivers. To request a penalty abatement, file IRS Form 843 along with copies of any documentation you may have to support your request.

Tax Tips: What to Do if Audited by the IRS

You’re being audited by the IRS. You don’t know exactly what you are in for, but you’re convinced that it can’t be good. You have heard the horror stories and you are bracing for the worst. While it’s true that an IRS notice is almost never good news, unless you have deliberately tried to scam the IRS, you should get through the ordeal OK.

Don’t Panic

First of all, don’t panic. You aren’t going to prison. You won’t end up destitute and living under a bridge. Even if you wind up owing the IRS big time, the odds are good that you will be able to work out a repayment plan. Back in the bad old days, the IRS earned its nasty reputation for ruthlessness. Abusive tactics by the IRS have been implicated in at least one case where a taxpayer was driven to suicide. These days, the IRS has significantly changed its approach to be more cooperative with taxpayers. Just in case you’re really worried: When does the IRS file criminal charges?

Determine What Type of Audit You Are Facing

Remember the letter you received from the IRS? Go back and read it again. The letter will inform you of the type of audit you are facing, which years are under investigation. It also shows the date and time the IRS expects you to provide the information it is seeking. In the best case scenario, the IRS is pursuing a correspondence audit covering one or two elements of a single year’s tax return, with a deadline by which the IRS expects to receive your reply. Correspondence audits are conducted entirely by mail and make up 75 to 80 percent of all audits. An in-person interview audit takes place at your local IRS office. A field audit is scheduled for a particular date and time, but takes place in your home or office. It is considered the most comprehensive type of audit.

Gather Your Documentation

Once you have determined what information the IRS is seeking, it’s time to begin gathering your paperwork. If the IRS is challenging a particular deduction or tax credit that you claimed, gather whatever documentation you have to support your claim, including bank statements, receipts and invoices. Provide as much information as possible concerning the inquiries the IRS has made, but do not volunteer information the IRS has not requested. Also, make photocopies of everything that you intend to provide to the IRS. Never give up your original documents.

Obtain Professional Representation If Necessary

For a correspondence audit covering only one or two simple inquires, you probably don’t need professional representation. But if you are among the 60 percent of Americans who hire professionals to prepare your tax returns, the same preparer should respond to an IRS correspondence audit. Even if you prepare your own returns, having a professional such as an attorney from Optima Tax Relief check out your response before you return it to the IRS may save you from making costly errors. If you have been contacted for an in-person interview audit or a field audit, the IRS allows you to be accompanied by a representative. If at all possible, take advantage of this opportunity. You will likely be nervous during the procedure, and may volunteer information that might prompt the IRS agent to probe beyond the original scope of inquiry. Having a professional present reduces this possibility.

Additional Tax Tips:

The IRS Criminal Investigation Process

How to Know if the IRS Is Auditing You

How to survive an IRS tax audit

Tax Tips: When does the IRS file criminal charges?

Statistically, your chances of being charged with criminal tax fraud or evasion by the IRS are minimal. The IRS initiates criminal investigations against fewer than 2 percent of all American taxpayers. Of that number, only about 20 percent face criminal tax charges or fines.

Related Article: The IRS Criminal Investigation Process

Unofficially, the minimum amount of unpaid taxes required to trigger an IRS criminal investigation is $70,000. And since the majority of Americans don’t even earn that much money, it’s easy to see why ordinary taxpayers need never worry about facing tax evasion or fraud charges.

While honest mistakes or even negligence generally won’t trigger a tax investigation, perpetrating fraud very well might. IRS agents are trained to recognize signs of criminal tax fraud and evasion. Exhibiting behaviors the IRS calls “affirmative acts” could eventually result in that fateful knock on the door from the IRS.

Negligence versus Tax Fraud

Back in the day, it seemed like the IRS was lying in wait, prepared to strike unsuspecting taxpayers at the slightest sign of tax error. These days the IRS is more tolerant of mistakes made by honest taxpayers.

When the circumstances are not clear cut, the IRS frequently errs on the side of giving the taxpayer the benefit of the doubt. Miscalculating the amount of your Earned Income Tax Credit is a mistake that could cost you a significant sum of money, but it isn’t usually considered to be tax fraud. Artificially concealing $800,000 of income by keeping two sets of books? Tax fraud. (Nolo)

Evidence of Fraud

Four so-called elements of fraud are recognized by the IRS: deception, misrepresenting material facts, submitting false or deliberately altered documents and failing to submit critical documents, such as tax returns. Several elements of fraud must occur together to trigger IRS fraud charges. But a single element that occurs in an especially blatant fashion may generate IRS tax fraud charges.

For instance, failure to submit a tax return for a single year is not usually considered to be an element of tax fraud. On the other hand, unless your income is extremely low, failing to file any tax returns ever could very well cause the IRS to initiate a criminal investigation against you.

Badges of Fraud

The list below, taken from the website, represents several “badges of fraud” the IRS looks for when determining whether to file criminal charges.

Badges of fraud fall into four general categories: improper reporting of income, unjustified deductions or tax credits, inadequate record keeping and outright illegal behavior. As with elements of fraud, IRS agents are inclined to give taxpayers the benefit of the doubt. They’ll impose penalties for taxpayers in arrears rather than bringing criminal charges against them.

  • Understatement or omission of substantial sums of money
  • Fictitious deductions
  • Maintaining “shadow” sets of accounting records
  • Deliberate destruction of records
  • Evidence of consistent underreporting of income
  • Obviously nonsensical explanations for behavior
  • Refusing to cooperate with an auditor or examiner·
  • Deliberately concealing assets, as in overseas tax shelters
  • Illegal activities
  • Dealing exclusively in cash
  • Maintaining obviously inadequate records
  • Indicators of Fraud

The IRS categorizes indicators of fraud into six broad categories: income, expenses and deductions, books and records, income allocation, methods of concealment and taxpayer conduct.

Just as with elements of fraud and badges of fraud, the difference between negligence and criminal conduct is often a matter of extent. Indicators of fraud usually include an element of deliberate conduct as well. An extensive list of actions that constitute indicators of fraud are available on the IRS website, but the examples below should provide a general idea of how the IRS views indicators of fraud.

Example #1:

Forgetting to include income from a W-2 form is not considered an indicator of income fraud. Insisting on being paid cash wages for a job and refusing to list any income from that job on your federal income tax return would be considered to be an indicator of income fraud.

Example #2:

Miscalculating the percentage of business versus personal use for your computer is not considered an indicator of fraud for expenses and deductions. Attempting to deduct the entire cost of your vacation to the Bahamas because you answered a single work-related email from your hotel room WOULD be.

Don’t Be Evasive

In general, if you suspect that a particular type of conduct is disallowed by the IRS, you shouldn’t do it. If you go ahead and do it anyway, you run the risk of being cited for tax evasion or tax fraud. And if you do receive that dreaded knock on the door from the IRS, you should not be surprised.

Additional Tax Tips:
What to do during an IRS Audit
How to survive an IRS tax audit

Dealing with an IRS Audit – 10 Expert Tips

You have received the dreaded notice that your tax return is being subjected to official review. In other words, you’re being audited. While an audit is never good news, neither is it necessarily a catastrophe. Keep your wits about you and follow a few strategies suggested by experts, and you will survive your audit and live to file another tax return.

1. Know What Type of Audit You Are Facing

There are three types of audits: correspondence or mail audits, office examination audits and field audits. An overwhelming percentage of all audits – approximately 75 to 80 percent – are correspondence audits. Correspondence audits are usually limited to one or two specific questions. Once the IRS receives satisfactory responses, you’re done.

Office examination audits are conducted at a local branch of the IRS. You will need to attend in person, but you are allowed to be accompanied by your accountant or attorney. Field audits are conducted on your turf and are the most comprehensive. As with office examination audits, you are allowed to have representation present during a field audit. In fact, it is highly advisable.

2. Understand What Auditors are Seeking

While each audit is different, all audits focus on three basic questions:

  1. Is your business truly a business – or just a hobby?
  2. Are your deductions legitimate?
  3. Did you report all your income?

If you can answer these three questions to the satisfaction of the auditor, you stand a good chance of emerging from an audit relatively unscathed.

3. Get Your Ducks in a Row Beforehand

Read the letter you receive carefully. If you are dealing with a correspondence audit, determine which documents you need to collect to respond to the questions posted in the audit notification letter. If you must report in person for an office audit or prepare your home or office for a field audit, ensure that your paperwork – and your representative – will be available and ready. Prepare your responses to the points that have been raised for the years that have been included in the audit notification letter.

4. Ask for More Time if Needed

In most cases, you should have sufficient time to adequately prepare for an audit. But if you must retrieve past year returns or other documents that are difficult to obtain, you may need more time.

Ask for a recess or an extension as soon as you know you will need one. If the IRS refuses, mention that you want more time to obtain professional advice – a request which the IRS must grant.

5. Be Totally Truthful in Your Responses

Seriously, lying to an IRS auditor is a bad idea. First, IRS auditors will frequently ask questions to which they already know the answers, just to determine if you are being straight with them. Get caught in that sort of a lie and you’re done. Second, IRS auditors are not likely to take your word for whatever you say. If you make a false claim, you will have to provide false documentation to back it up. Can you see how this sort of conduct could eventually lead to a criminal tax fraud or tax evasion charge? Just don’t do it.

6. Don’t Volunteer Information

Be as transparent as possible in your responses to the questions you are asked. At the same time, do not volunteer information that the IRS agent has not requested. If your audit only covers two years worth of taxes, don’t offer paperwork for the last decade’s worth of expenses. If you want to prepare documentation for the past decade just in case, that’s fine, but let the IRS agent do his or her own job.

7. Substantial Compliance Is Your Friend

Nobody is perfect. Even the IRS recognizes this. If you can prove that you have properly claimed a tax deduction or credit, odds are good that the IRS agent will allow it, even if you lack some documentation. The IRS calls this substantial compliance. This doesn’t mean that you can be sloppy about documentation. It does mean that if you just can’t find one drink receipt from a business trip but your hotel bill, airfare receipts, meeting agenda and other documentation are in order, you can probably relax.

8. If You Disagree, Appeal

If you disagree with the outcome of an IRS audit, you do have the right to appeal. Begin by contacting the auditor directly. If you can’t get satisfaction that way, go to his or her superior. If you’re still not satisfied, more formal recourse is available.

One option is to request alternative dispute resolution (ADR). You may also file a request with the Office of Appeals. You may also file legal action with the Tax Court. If you are slapped with tax penalties in addition to owed taxes, you may be able to get at least some of them waived, reduced or abated — eliminated altogether. (

9. If You Agree but Can’t Pay, Negotiate

If you agree with the outcome of the audit, even grudgingly, but you just don’t have the cash to pay what you owe in full, don’t panic. Pay what you can and negotiate for terms you can deal with to cover the rest. If you owe $25,000 or less, you may request an installment agreement by filing Form 9465, Installment Agreement Request either online, by mail or in person. If you owe more than $25,000, file Form 9465-FS, Installment Agreement Request. You may also make payments by automatic payroll deduction by filing Form 2159, Payroll Deduction Agreement.

Related article: Top 10 Benefits of Working with a Professional Tax Relief Firm

10. Don’t Go it Alone

With the very simplest of correspondence audits, you may be able to gather the necessary paperwork and respond on your own. Nonetheless, it doesn’t hurt to have an accountant or a tax professional like those at Optima Tax Relief check over your response before you send it to the IRS. For in-person audits, hiring a professional to help you deal with your audit is highly advised. If you aren’t sure, find out if you need to “lawyer up” here.