Tax Laws: What the IRS Can Do and When to Push Back

An IRS audit is an examination of a taxpayer's return to verify that income, deductions, and credits are accurately reported, and the scope of the audit ranges from a correspondence audit requesting documentation for a single item to a field audit examining multiple years and all aspects of the taxpayer's financial records.

Taxpayers have the right to be represented by counsel during an audit, to record interviews with IRS agents with advance notice, and to appeal any proposed adjustments before they become a final assessment. The IRS must follow specific procedural requirements before assessing tax, including issuing a statutory notice of deficiency that gives the taxpayer 90 days to file a petition in the U.S. Tax Court. Filing a Tax Court petition stops the assessment and allows the dispute to proceed through judicial review before any tax is collected. An attorney who handles tax audits and adjustments can represent the taxpayer during the examination and identify which proposed adjustments are legally or factually incorrect before the notice of deficiency is issued.

The trust fund recovery penalty under 26 U.S.C. § 6672 makes responsible persons within a business personally liable for the employee withholding portion of unpaid payroll taxes, and the penalty reaches individuals who had authority over the business's finances even when they did not know the taxes were not being paid.

A responsible person is any person who had the duty to collect, account for, and pay over payroll taxes and who willfully failed to do so. Willfulness under § 6672 does not require bad intent. It requires only that the responsible person knew the taxes were unpaid and chose to pay other creditors instead, which courts have consistently held satisfies the willfulness standard. Officers, directors, and shareholders with signature authority over company accounts are frequently assessed the trust fund recovery penalty even when the company's failure to pay was caused by financial distress rather than intentional evasion.

The trust fund recovery penalty equals 100 percent of the unpaid withholding taxes and cannot be discharged in bankruptcy. An attorney who handles payroll tax compliance and § 6672 penalty defense matters can contest whether the taxpayer was actually a responsible person, whether the failure to pay was willful under the applicable standard, and whether the penalty amount was correctly calculated.

The IRS's collection due process rights give taxpayers the opportunity to request a hearing before a levy is executed, challenge the underlying liability if it was not previously contested, and propose collection alternatives including offers in compromise and installment agreements. The deadline to request a collection due process hearing is 30 days from the final notice before levy. Missing this deadline eliminates the right to Tax Court review of the collection action and leaves only a less protective equivalent hearing with no judicial review option.

U.S. .ersons with financial interests in or signature authority over foreign bank accounts valued above $10,000 at any point during the calendar year must file a Report of Foreign Bank and Financial Accounts, known as an FBAR, with the Financial Crimes Enforcement Network by April 15 of the following year.

FBAR violations carry civil penalties that are separate from income tax penalties and can reach the greater of $100,000 or 50 percent of the account balance per violation for willful failures to file. The Supreme Court's decision in Bittner v. United States, 598 U.S. 85 (2023), held that the $10,000 non-willful FBAR penalty applies per report, not per account, significantly limiting penalties for non-willful filers with multiple accounts. Criminal FBAR violations carry up to five years in federal prison and fines of up to $250,000.

FATCA, the Foreign Account Tax Compliance Act codified at 26 U.S.C. § 6038D, requires U.S. .ersons to disclose specified foreign financial assets on Form 8938 filed with the tax return when the aggregate value exceeds applicable thresholds. An attorney who handles FBAR and FATCA compliance matters can evaluate whether a taxpayer's foreign account history creates criminal exposure or whether a voluntary disclosure program provides a path to resolving past non-compliance with reduced penalties.

The IRS Voluntary Disclosure Program allows taxpayers with potential criminal exposure for willful tax violations to come forward, cooperate with the IRS, and pay back taxes and penalties in exchange for a recommendation against criminal prosecution. The program is not available to taxpayers who are already under examination, who have already been contacted by IRS Criminal Investigation, or who believe the IRS has already obtained information about their unreported income from third parties. Timing determines eligibility, and the window for voluntary disclosure closes when the investigation begins.

Civil tax fraud under 26 U.S.C. § 6663 applies when any portion of a tax underpayment is attributable to fraud and results in a 75 percent penalty on the fraudulent portion. Criminal tax evasion under 26 U.S.C. § 7201 requires proof beyond a reasonable doubt that the defendant willfully and intentionally evaded tax through affirmative acts, and it carries up to five years in federal prison per count. The key distinction is intent: civil fraud requires clear and convincing evidence, while criminal tax evasion requires the higher willfulness standard and must be proved beyond a reasonable doubt.

The IRS generally has three years from the date a return is filed to assess additional tax under 26 U.S.C. § 6501. The period extends to six years when the taxpayer omitted more than 25 percent of gross income. There is no statute of limitations when the taxpayer files no return or files a fraudulent return. For FBAR penalties, the statute of limitations is six years from the due date of the FBAR. Understanding which limitations period applies requires examining the specific facts of what was filed, what was omitted, and whether any fraudulent intent was involved.

An offer in compromise is a settlement program under 26 U.S.C. § 7122 that allows taxpayers to resolve their federal tax debt for less than the full amount owed. The IRS evaluates offers based on the taxpayer's reasonable collection potential, which is the present value of the taxpayer's assets plus income available to pay taxes after allowable living expenses. Taxpayers with unfiled returns, those currently in bankruptcy, and those who can pay the full liability are not eligible. The IRS accepts roughly 40 percent of submitted offers, and the acceptance rate is significantly higher for offers supported by complete and accurate financial documentation.

Unpaid payroll taxes create liability both for the business entity and personally for responsible persons under 26 U.S.C. § 6672. The trust fund recovery penalty equals 100 percent of the employee withholding that was not paid and is assessed against any person who had authority to pay the taxes and willfully failed to do so. Courts have found willfulness when a responsible person knew taxes were unpaid and chose to pay other creditors instead. The personal liability cannot be discharged in bankruptcy, making it one of the most serious tax liabilities an individual can face.

FBAR is the Report of Foreign Bank and Financial Accounts, required of any U.S. .erson with a financial interest in or signature authority over a foreign financial account exceeding $10,000 at any point during the year. Willful failure to file carries civil penalties of up to 50 percent of the account balance per violation and criminal penalties of up to five years in federal prison. Non-willful failures carry a $10,000 penalty per report under the Supreme Court's 2023 Bittner decision. Taxpayers with unfiled FBARs may be able to resolve past non-compliance through the IRS Streamlined Filing Compliance Procedures or the Voluntary Disclosure Program depending on whether the failure was willful.

Yes. Filing a petition in the U.S. Tax Court within 90 days of receiving a statutory notice of deficiency allows a taxpayer to dispute the proposed assessment without first paying the tax. The Tax Court is the only federal forum in which the taxpayer can challenge the liability before paying. Alternatively, a taxpayer can pay the disputed tax, file a claim for refund with the IRS, and if the refund is denied, sue for refund in federal district court or the Court of Federal Claims. An attorney who handles income tax compliance and IRS dispute matters can evaluate which forum provides the most favorable procedural posture given the specific issues in dispute.