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How to Avoid Tax Penalties After an Audit

Hoiw to avoid paying penalties after a tax auditThe good news: You survived an audit. So what now?

If you're 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're 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're 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. The IRS goes so far as to suggest that you consider a home equity loan, personal loan or credit card, since penalties and interest for your taxes may cost you more over the long run.If you can't afford to pay the tax due in full and you have no other 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) (note that the online system is unavailable until after January 10, 2011). You can also enter into an agreement manually by filing 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 as noted above, and you may also need to file a form 433F, Collection Information Statement. 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 can't afford an installment plan, you may consider an offer in compromise (OIC) as a last resort. With an OIC, the IRS agrees to settle your outstanding 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. Unfortunately, the IRS isn't agreeing to many OICs right now; the rejection rate is about 80%.

You can 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 doesn't automatically stop penalty and interest from accruing; that won't stop unless your appeal is granted.

The IRS cautions you to beware of claims made by some attorneys and promoters that tax debts can be settled through the OIC program and other tax resolution strategies for "pennies on the dollar." This rarely happens. Several high profile cases, such as the one involving Roni Deutch, have called attention to schemes that promise tax relief which might not be available. OIC agreements and other abatements can only be negotiated with the IRS -- you should be wary of a upfront promise by a third party to significantly reduce your tax debts.

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.

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