What Happens If You Get Caught Taking Deductions You Shouldn't in a Tax Audit?

By Markets Fool.com

Getting audited by the IRS is one of the biggest fears that Americans have, and most people therefore have a healthy respect for the tax man. Nevertheless, if you do get audited, there's a possibility that the IRS will discover that you've taken a deduction that you weren't entitled to take. Knowing the consequences is important so that you won't be surprised at the end of a tax audit. Below, we'll go into more detail on what happens if you get caught making a big tax mistake.

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What happens after an audit?

Many tax audits end without any adjustment being made to your taxes at all. In some cases, the IRS simply lacks the supporting documentation to verify the deductions you've taken. Once you provide that documentation, the audit ends favorably with no further consequences.

However, if you're charged additional tax as a result of an audit, you'll typically have to pay interest and penalties on the unpaid tax for the period from when you should have paid the tax and when you actually do pay it. Interest varies depending on the rates that apply for the particular time period. If penalties are assessed, the penalty for failing to pay on time is 0.5% of the amount owed for every month that you're late paying it, up to a maximum of 25%.

Fraud vs. negligence

In addition, the IRS has the right to add on extra penalties if it believes that your error was particularly egregious. If the IRS finds that you were negligent in making a mistake on your tax return, then it can assess a 20% penalty on top of the tax you owe as a result of the audit. This additional penalty is intended to encourage taxpayers to take ordinary care in preparing their tax returns.

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On the other hand, if you're found to have committed tax fraud, then the penalty is much higher: 75% of your tax liability. It can be hard to distinguish fraud from negligence, but typically, fraud implies a deliberate act that's intended to help you evade taxes.

You always have the right to fight the assessment of any penalties even if you're found to have taken improper deductions or other tax breaks in a tax audit. The better course is to be accurate in preparing your taxes in the first place so as to avoid the need for an audit at all.

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