In our last post, we spoke briefly about some of the general factors tax authorities will look out for when determining the nature of taxpayer noncompliance—whether it is due to negligence or fraud. As we noted, the penalties are different depending on whether the noncompliance is based on fraud or negligence.

When building a case for penalties, tax auditors are trained to gather information about a variety of factors related to a noncompliant return, including the taxpayer’s (or tax preparer’s) background and knowledge of tax law, his or her familiarity with the operations of any business involved, and his or her knowledge of how records are kept. Tax authorities will usually ask, as well, whether the taxpayer is aware of any errors. 

Tax auditors will also solicit a taxpayer’s explanations for any discrepancies, and it should be kept in mind that there are circumstances that can lead to abatement of penalties. Taxpayer explanations vary, but can include things like: lack of knowledge; reliance on a tax preparer; and that there are off-setting adjustments to unreported income. The circumstances of each case vary, and the IRS is utilizes established guidelines to determine the reasonableness of explanations and the impact on any penalties that may be levied. In considering the possibility of abatement, tax authorities will look at things like the taxpayer’s history of compliance, his or her ability to anticipate whatever event may have caused noncompliance and the length of time it took for the taxpayer to come into compliance.

Tax auditors are supposed to be fair and consistent in applying penalties, and are not supposed to use penalties as leverage or to punish an uncooperative taxpayer. Rather, penalties are supposed to be based on the Internal Revenue Code or other established authority. Taxpayers do have the opportunity to respond to a tax auditor’s conclusions, including any penalty determinations.

Navigating the tax audit process can be a scary thing for individuals and businesses, but having an experienced advocate can help the process go more smoothly and ensure one’s rights are protected. The line between fraud and negligence can be fine, and the penalties for fraud steep, so it is particularly important to have an advocate when one’s case is referred for a criminal investigation.