There are a wide variety of IRS tax penalties available for different situations that arise. If you forget to file your tax return, there’s a tax penalty for that. If you can’t pay the tax due, there’s a tax penalty for that. If the tax return you file isn’t correct, there’s a tax penalty for that.
Let’s dive in and explore some of the most common IRS tax penalties.
Don’t Be Late: Delinquency Tax Penalties
The most common delinquency penalties are:
- failure to file a tax return,
- failure to pay tax,
- failure by an individual to pay estimated income tax,
- failure by a corporation to pay estimated income tax, and
- failure to make employment tax deposits.
Failure to File Penalty and Failure to Pay Penalty
If you do not file a return on time, you could be penalized under 26 U.S.C. Section 6651(a)(1). There are many types of returns that are subject to the failure to file penalty including:
- individual returns,
- corporate income tax returns,
- employment tax returns,
- gift tax returns, and
- trust returns.
The penalty is calculated from the date the return was due, including any properly filed extensions. The failure to file penalty is 5% per month of the net tax due, up to 25%.
The failure to pay penalty penalizes those who are late in paying their taxes. The failure to pay penalty is usually ½% per month of the net tax due. In certain circumstances, it can be as low as ¼% and as high as 1% a month.
When you also factor in the interest, this can quickly add up.
Failure to Pay Estimated Taxes
Individuals and corporations both face penalties for failing to make estimated tax payments. Estimated taxes are essentially deposits you make throughout the year. When you file a return showing a total tax, you are credited for the tax you already paid. This helps lessen the blow when the tax is actually due.
Corporations and individuals are penalized at the same rate, which is calculated the same as the interest calculation.
Failure to Make Employment Tax Deposits
Penalties for failing to make employment tax deposits are more severe than most other delinquency penalties. If you are late by 5 days or less, the penalty is 2%. If you’re between 6-15 days late, the penalty is 5%. If you’re over 15 days late, the penalty is 10%. And if the IRS sends you a notice about the delinquency, it’s a 15% penalty.
As someone who’s helped countless taxpayers with their payroll tax issues, I’ve seen how this penalty can really compound the issue when a company falls behind in employment tax deposits. When there’s a cash shortage, businesses are tempted to stop paying employment taxes and pay other expenses, like rent or utilities. They rationalize the move by saying they need to keep the lights on to stay in business. But “borrowing” from employment taxes is a terrible idea with significant penalties.
When a Tax Return Is Not Quite Right: Accuracy-Related Tax Penalties
The second class of tax penalties is accuracy-related penalties. Accuracy-related penalties include:
- negligence penalty,
- substantial understatement penalty,
- tax shelter items,
- substantial valuation misstatements,
- substantial gift or estate tax valuation understatement, and
- fraud penalty.
Negligence Penalty and Substantial Understatement Penalty Are Common Tax Penalties.
The negligence penalty and substantial understatement penalty can common come up at the conclusion of an audit. Both are 20% tax penalties on the portion of the underpayment of tax that’s due to negligence or a substantial understatement of tax. Under 26 U.S.C. 6662, there are many other scenarios where a 20% penalty could be imposed.
The 20% penalty is a one-time flat rate. Unlike the failure to file and failure to pay penalties, it does not accrue monthly.
There are a couple ways to avoid the penalty. First, you can avoid the penalty if there’s “substantial authority” supporting the position on your return that led to the underpayment. Second, you can avoid the penalty if there’s adequate disclosure of the item on the return and there’s a reasonable basis for the tax position taken. These standards are murky, but essentially, you must show you reasonably relied on laws or cases that support the position taken. Practically speaking, if you can raise enough hazards at appeals, you can likely have the penalty at least reduced.
The Fraud Penalty is One of the Most Severe Tax Penalties.
If you are audited and any part of the underpayment is due to fraud, the IRS will tack on a 75% penalty. The 75% penalty will apply to the entire underpayment amount unless you can prove certain line items are not due to fraud. Anytime the fraud penalty comes up, there is also a risk the case will get referred to the criminal division. This tax penalty will be discussed in great detail in a coming post devoted entirely to it. If you’re being audited and believe you may be hit with a fraud penalty, contact a tax attorney immediately.
FAQs about Tax Penalties
How Do You Get Tax Penalties Removed?
Delinquency penalties can be abated (legal jargon for removed) if you can show reasonable cause. You must show you exercised ordinary business care and prudence but still could not file the return timely or pay the tax timely. Some common reasons given:
- death, serious illness, or unavoidable absence
- fire, casualty, natural disaster, or other disturbance,
- unable to obtain records,
- a mistake was made,
- erroneous advice or reliance,
- ignorance of the law, and
The fact that a mistake was made or that you forgot to file or pay a return won’t rise to the level of reasonable cause. But if you were extremely ill and couldn’t file or pay timely, you have a better chance of obtaining relief.
You can also get certain penalties—including the failure to file and failure to pay penalties—removed through the first time abatement process. If you do not have a similar penalty for the previous three years, the IRS will remove the penalty without needing to show reasonable cause.
Accuracy-related penalties, like the fraud penalty and the negligence penalty, should only be imposed on the portion of the underpayment that’s attributable to fraud or negligence. For instance, let’s say you “fluffed” a deduction on your return, and the IRS auditor wants to impose a negligence or substantial understatement penalty. Most auditors will try and impose the penalty on all adjustments, whether or not they are due to negligence or a substantial understatement. In this situation, it may be best to concede the one item, and have a lesser or no penalty assessed on the other items.
Can Tax Penalties Be Waived?
Tax penalties can be waived through:
- a penalty abatement,
- bankruptcy (but not all types of penalties), and
- a successful innocent spouse claim.
Penalty abatements are the most common way to have penalties waived. Most penalty abatement claims are rejected upon initial review, but they can be appealed. You are much more likely to have penalties waived or at least reduced in appeals.
Can Tax Penalties Be Deducted?
Usually, penalties cannot be deducted. This makes sense from a public policy standpoint. There are narrow circumstances where penalties can be deducted, but don’t count on it.
Can You Negotiate Tax Penalties?
Penalties are most likely to be negotiated during the appeal of an audit. This is your chance to present reasonable cause arguments and other reasons the penalties may be inappropriate. Penalties can also be negotiated through the penalty abatement process.
Looking for Help With Your IRS Tax Penalties? Contact a New Jersey Tax Attorney.
If you need help figuring out whether there’s a way to reduce or remove penalties, Paladini Law can help. We have experience reducing and eliminating tax penalties. Call us or contact us here.