Many tax penalties are substantial and can significantly increase the amount you owe the IRS. Penalties can be assessed for various reasons, with some resulting from a taxpayer’s carelessness, overstatement of deductions, failing to report income, or procrastination.
You can also be penalized for intentional acts of fraud and/or filing frivolous tax returns.
The following are some common tax penalties that the IRS imposes on taxpayers.
•Filing and Paying Late – These penalties apply when a taxpayer fails to file a return on time or does not pay the amount owed. The maximum late filing penalty is 5% of the unpaid tax for each month or part of a month that the return is late, but not more than five months. The late payment penalty is ½% per month and continues until the tax is paid or it reaches a maximum of 25%.
However, when the late payment penalty applies, the 5% late filing penalty is reduced to 4½%, resulting in a combined monthly penalty of 5%. The combination of these penalties can reach as high as 47½%.
If a taxpayer files their tax return more than 60 days after the due date, the minimum penalty is $205 or 100% of the balance of the tax due on the return, whichever is smaller.
•Underpayment of Estimated Tax – Our tax system is a “pay-as-you-go” system. To facilitate payment of your taxes, the government provides several means of helping taxpayers fulfill their tax obligations. These include:
- Payroll withholding for employees;
- Pension withholding for retirees; and
- Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.
When a taxpayer fails to prepay the required amount, he or she can be subject to the underpayment penalty. This penalty is currently 4% and is computed on a quarterly basis.
There are several instances when the underpayment penalty will not be applicable. If the underpayment is less than $1,000, no penalty is assessed. In addition, the law provides “safe harbor” (minimum) prepayments. There are two safe harbors, which are discussed below:
- The first safe harbor is based on amount of tax owed in the current year. If a taxpayer’s payments equal or exceed 90% of what is owed in the current year, there is no penalty.
- The second safe harbor is based on the tax owed in the prior tax year. This safe harbor is generally 100% of the last year’s tax liability. However, for higher-income taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.
•Dishonored Check – A penalty is charged if a taxpayer’s check is returned because of insufficient funds. For checks of $1,250 or more, the penalty is 2% of the check amount. For checks of less than $1,250, the penalty is the lesser of $25 or the amount of the check.
• Negligence or disregard of rules and regulations– An accuracy-related penalty of 20% penalty is imposed on the portion of any tax underpayment that is due to negligence or disregard or the rules and regulations.
“Negligence” includes any failure to make a reasonable attempt to comply with the law or to exercise ordinary and reasonable care in preparing a tax return, as well as failure to keep adequate books and records or substantiate items properly. “Disregard” includes any careless, reckless or intentional disregard.
Indications of negligence include (a) unreported or understated income; (b) deductions or credits significantly overstated; (c) careless, improper, or exaggerated deductions; (d) misrepresenting or miscategorizing deductions in such a manner as to conceal the true nature of the deduction; and (e) providing incorrect or incomplete information to prepare the return.
•Fraud – The civil fraud tax penalty is one of the most powerful tools that the IRS has. This penalty applies if any part of a tax underpayment is due to fraud, and the penalty equals 75% of that portion of the taxpayer’s underpayment attributable to fraud. Although the IRS has the burden of proving fraud with clear and convincing evidence, if it shows that any portion of an underpayment is due to fraud, the entire underpayment is treated as attributable to fraud except for any portion that the taxpayer shows (by a preponderance of the evidence) not to be attributable to fraud.
No time limit exists on the assessment and collection of tax if a fraudulent return is filed. Likewise, a return subject to the civil fraud penalty is treated as fraudulent for bankruptcy purposes. As a result, taxes shown on such a return are not normally discharged in a bankruptcy proceeding.
•Frivolous Tax Return – Anyone who submits a tax return or makes any other submission to the IRS that includes or is based upon any frivolous tax argument can be subject to a $5,000 penalty. A frivolous return is one that does not contain information needed to figure the correct tax or shows a substantially incorrect tax because the taxpayer takes a frivolous position or desires to delay or interfere with the tax laws. According to the IRS, frivolous tax arguments involve making “unreasonable and outlandish claims to avoid paying… taxes.” The IRS releases a document each year summarizing the arguments that are considered frivolous.
It is possible that some of the above penalties can be reduced or removed if a taxpayer can show reasonable cause. Reasonable cause relief is generally granted when the taxpayer exercises ordinary business care and prudence in determining their tax obligations but is unable to comply with those obligations. Each case is judged individually based on its particular the facts and circumstances. Penalties may also be removed under the First Time Abatement Policy.
If you have been assessed tax penalties by the IRS, call our office today for a free consultation to determine whether you are a candidate for penalty relief.