1. How Tax Laws Create Liability and When the IRS Can Assess Additional Tax
Federal tax liability arises when a taxpayer files a return, when the IRS audits a filed return and determines additional tax is owed, or when the IRS substitutes its own calculation through a substitute for return when no return was filed.
The standard three-year statute of limitations on assessment under 26 U.S.C. § 6501 gives the IRS a defined window within which it can audit and assess. A taxpayer who files on time and accurately reporting all income has significant protection from open-ended audit exposure. A taxpayer who omits more than 25 percent of gross income from a return extends the IRS's assessment window to six years, and a taxpayer who files no return or a fraudulent return faces an unlimited assessment period.
Civil tax penalties range from the 20 percent accuracy-related penalty under 26 U.S.C. § 6662 for negligence or substantial understatement of tax, to the 75 percent civil fraud penalty under 26 U.S.C. § 6663, which applies when any portion of the underpayment is attributable to fraud.
How IRS Audits Are Conducted and What Rights Taxpayers Have during One
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.
| IRS Enforcement Action | When It Occurs | Taxpayer Response Deadline | Effect If No Response |
|---|---|---|---|
| Notice of deficiency | After audit proposes additional tax | 90 days to petition Tax Court | Assessment becomes final |
| Tax lien filing | After assessment and demand | Hearing request within 30 days | Lien attaches to all property |
| Tax levy | After lien and final notice | CDP hearing request within 30 days | Seizure of wages, accounts, property |
| Criminal referral | After civil division suspects fraud | Immediately upon notice | Grand jury investigation proceeds |
2. What Tax Laws Provide When Taxpayers Cannot Pay What Is Owed
The Internal Revenue Code provides several collection alternatives for taxpayers who owe more than they can pay, and each alternative has specific eligibility requirements, procedural deadlines, and consequences for future compliance.
An offer in compromise under 26 U.S.C. § 7122 allows a taxpayer to settle a federal tax debt for less than the full amount owed when full payment would create an economic hardship or when there is doubt as to the liability or the IRS's ability to collect. The IRS evaluates offers based on the taxpayer's reasonable collection potential, which is calculated from the taxpayer's assets, income, and allowable living expenses. Taxpayers in active bankruptcy proceedings, those who have not filed all required returns, and those who can pay the full liability are not eligible.
Installment agreements allow taxpayers to pay the full liability over time in monthly payments, with interest and late payment penalties continuing to accrue. The IRS's collection statute of limitations under 26 U.S.C. § 6502 gives the IRS ten years from the date of assessment to collect, and an installment agreement tolls this period. An attorney who handles offer in compromise and IRS tax levy defense matters can calculate the reasonable collection potential and determine which resolution option produces the most favorable outcome given the taxpayer's specific financial situation.
How Payroll Tax Liability Becomes Personal under Irc Section 6672
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.
3. When Tax Laws Lead to Criminal Prosecution
Criminal tax charges are reserved for conduct that goes beyond civil noncompliance and involves intentional evasion of tax obligations or affirmative acts to conceal taxable income, and the consequences include federal imprisonment and fines that civil penalties cannot impose.
Tax evasion under 26 U.S.C. § 7201 requires proof that the defendant had a tax deficiency, that the defendant engaged in an affirmative act to evade or defeat the tax, and that the act was willful. The willfulness element in criminal tax cases requires proof that the defendant knew of their legal duty to pay taxes and intentionally violated that duty, a standard the Supreme Court addressed in Cheek v. United States, 498 U.S. 192 (1991), which held that a good faith misunderstanding of the tax law, even an unreasonable one, negates willfulness.
Filing a false return under 26 U.S.C. § 7206(1) is a separate offense that does not require a tax deficiency and carries up to three years in federal prison per count. A taxpayer who underreports income on a return, whether or not additional taxes are ultimately owed, commits a § 7206(1) offense for each false return filed. An attorney who handles tax fraud and criminal tax defense matters can evaluate whether the IRS civil division's referral to the criminal division has a sufficient evidentiary basis and advise on whether voluntary disclosure before criminal charges are filed remains a viable option.
How Fbar and Fatca Obligations Create Separate Penalties Outside the Tax Code
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.
4. Frequently Asked Questions about Tax Laws
Tax law generates more questions than almost any other area of law, and the questions that matter most to individuals and businesses are rarely the ones tax software answers. The most urgent practical questions across individuals, business owners, and taxpayers with foreign accounts are addressed directly below.
What Is the Difference between Civil Tax Fraud and Criminal Tax Evasion?
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.
How Long Does the IRS Have to Audit My Tax Return?
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.
What Is an Offer in Compromise and How Do I Qualify?
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.
What Happens If My Business Does Not Pay Payroll Taxes?
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.
What Is Fbar and What Happens If I Did Not File?
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.
Can I Go to Tax Court without Paying the Disputed Tax First?
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.
23 Jun, 2025
