How to avoid tax penalties after an audit
If you are audited and the result is that there are no adjustments to your return (or if you get a refund), it decreases your odds of being audited in subsequent years. If you are audited on the same items two years in a row with no additional taxes due, the IRS manual actually recommends that you not be audited for the same items for another year.
But what if you are audited and the IRS finds that you owe additional tax? You'll want to resolve those outstanding tax liabilities as soon as possible in order to avoid further interest and penalties.
If you can afford to pay the tax due in full, you'll prevent any future penalties and interest from piling up. If you can't afford to pay the tax due in full from your regular operating account, consider dipping into savings accounts or money markets. It may even be advantageous to consider a home equity loan, since penalties and interest for your taxes are likely more than the interest rate on a home equity loan.
If you can't afford to pay the tax due in full and you have no resources available, you may want to consider a payment plan with the IRS. If you owe less than $25,000 in combined tax, penalties and interest, you can enter into an Online Payment Agreement (OPA). You can also download a form 9465, Request for Installment Agreement .
If you owe more than $25,000 in combined tax, penalties and interest, you must file the form 9465 and an additional form 433F. In addition to making installment payments on time, the terms of an installment agreement require that all necessary tax returns be filed and payments made timely. You should be aware that penalties and interest will continue to be charged on the unpaid portion of the debt throughout the duration of the installment agreement/payment plan. However, those penalties and interest will be less with an installment agreement than taking no action at all.
If you cannot afford an installment plan, you may consider an offer in compromise (OIC) as a last resort. With an OIC, the IRS and the taxpayer agree to settle the taxpayer's debt for less than the amount of taxes owed, even after an audit. With an OIC, the total amount of tax, including penalty and interest, may be reduced, which sounds great. Unfortunately, the IRS is not accepting a large number of OICs right now; the rejection rate is about 75%.
Finally, you may also request that penalties and interest be removed if you have reasonable cause for your payment problems. The IRS considers reasonable cause as: "when a taxpayer exercises ordinary business care and prudence in determining their tax obligation, but is unable to comply with those obligations due to circumstance beyond their control." This is a higher standard than simply not having the funds available; an example may be a serious illness.
To request an abatement of penalty, you must send a written request to the Service Center asking the IRS to remove the penalty (you'll see the address on your notice of payment). If the Service turns you down, you'll receive a Notice of Disallowance, which will explain your rights of appeal. Filing the appeal does not automatically stop penalty and interest from accruing; that will not stop unless your appeal is granted.
Moving forward, the best way to avoid penalties is to file and pay on time. If you've been assessed for additional tax following an audit, chances are, you'll hear from Uncle Sam again. So, be smart. File on time and make payments on time. You'll save money in the long run.