Federal Tax Procedures & Penalties: From IRS Audits to FBAR Filing
Overview: The U.S. tax system relies on voluntary self-assessment — but the IRS audit process ensures compliance. This guide covers how audits are selected, what happens during an appeal, key tax courts, common taxpayer penalties, and foreign account reporting.
✅ How IRS Audits Work
- Selection: Uses statistical models like the DIF system, random sampling, prior year audits, info return mismatches, or deductions that exceed norms.
- Timing: Most individual returns audited within 2 years. Large corps are subject to annual audits.
- Correspondence vs. Office vs. Field: Simple math errors → correspondence audit. More complex → office or field audit with IRS agent.
✅ After the Audit: Agree or Appeal
- Agreement: Sign Form 870; interest stops accruing.
- No agreement: Get a 30-day letter for administrative appeal. Appeals Division tries to settle without litigation (Form 870-AD). No deal? Then you get a 90-day letter (notice of deficiency) to go to court.
✅ Federal Tax Courts Overview
- U.S. Tax Court: Only pay if you lose; no jury. Small Cases Division available for disputes under $50,000.
- U.S. District Court: Must first pay the tax, then sue for refund. Jury trial option.
- U.S. Court of Federal Claims: Nationwide, for refund suits. No jury trials.
- Appeals: Circuit Courts of Appeals or Federal Circuit. Final level: U.S. Supreme Court (rare for tax).
✅ Key Taxpayer Penalties
- Failure-to-File: 5% per month up to 25% (min $485 if 60+ days late).
- Failure-to-Pay: 0.5% per month up to 25% of unpaid tax.
- Negligence & Substantial Understatement: 20% penalty applies for careless mistakes or significant misstatements.
- Fraud: 75% civil penalty + possible criminal penalty up to $100,000 ($500,000 for corporations) plus jail time if proven willful.
✅ Reasonable Basis, Substantial Authority & More-Likely-Than-Not Standards
- Reasonable Basis: ≥ 20% chance of success in court → helps avoid negligence penalty.
- Substantial Authority: > 40% chance; official sources like IRC, Regs, IRS Rulings, court cases.
- More-Likely-Than-Not: > 50% chance; applies to listed transactions/tax shelters.
✅ FBAR Foreign Account Reporting
- U.S. persons with foreign financial accounts >$10,000 aggregate must file FinCEN Form 114 by April 15 (automatic 6-month extension).
- Records for each account must be kept for 5 years: name, account number, bank name/address, max value during year.
- Joint accounts? Each owner must file, unless spouse exemption applies.
🔗 Helpful References
👉 Know your rights and responsibilities — stay ahead of audits, appeals, penalties, and offshore reporting!
