How To Identify Whether You Owe an IRS Tax Penalty

For failing to fulfill your obligations as a taxpayer, the IRS may impose a variety of punitive tax penalties. If you miss a deadline or don't pay your tax payment on time, the IRS will automatically impose some penalties. Other fines are only imposed if the IRS determines that you engaged in tax fraud or evasion with the intent to break the law.

By submitting an accurate tax return and paying your taxes on time, you can avoid or reduce the majority of IRS tax penalties. You may be able to employ penalty abatement to lower your debt if the IRS assesses you a tax penalty.

What Are the Types of Penalties?

Following are some penalties you may receive notices and letters for:

  1. Taxpayers who fail to appropriately submit their mandatory information return or payee statement by the deadline are subject to an Information Return.
  2. When you fail to file your tax return by the deadline, it counts as Failure to File.
  3. When you don't make your tax payment before the deadline, Failure to Pay is the result.
  4. When you under report your income or claim credits or deductions for which you are ineligible, Accuracy-Related penalty applies.
  5. When you file a claim for an excessive refund or credit of income tax and there is no valid basis, you will be subject to Erroneous Claim for Refund or Credit Penalty.
  6. When you don't accurately or promptly pay employment taxes, Failure to Deposit is applicable.
  7. When tax return preparers act improperly, they are subject to Tax Preparer Penalties.
  8. When your bank rejects your cheque or another form of payment, it is referred to as a Dishonored Check.
  9. When you don't accurately or promptly pay estimated tax for a corporation, you are in violation of the Underpayment of Estimated Tax by Corporations rule.
  10. An individual’s failure to make timely or accurate estimated tax payments is in violation of the "Underpayment of Estimated Tax by Individuals" rule.
  11. Certain taxpayers who fail to accurately and promptly record financial activities with an international component are subject to International Information Reporting.

How Do You Know You Owe a Penalty?

An official notification or letter is mailed whenever the IRS imposes a penalty. The notification or letter will outline the punishment, the basis for the accusation, and the steps to be taken. These notices and letters are marked by a distinct identification number.

Make sure the data in your letter or notification is accurate. A penalty could not be imposed if you can find a solution in your notice or letter.

For more information, refer to Understanding Your Notice or Letter.

Circumstances where penalties are levied by the IRS

Here are four typical tax fines that the IRS imposes on people along with advice on how to avoid them.

Failure to file

Tax returns for this year are due on April 18, 2023. You have until October 15 to file your return if you need additional time; you can do so by requesting an extension. The IRS imposes a failure-to-file penalty if you fail to request an extension or fail to meet the extended deadline.

For each month or portion of a month that your return is late, a tax penalty equal to 5% of the unpaid tax is imposed. However, it is limited to 25% (5 months) of your balance. A minimum penalty is imposed if your return is submitted more than 60 days late. For returns due after 1/1/2020, the minimum penalty is $435 or 100% of the tax payable, whichever is less.

Even if you are unable to pay the sum due, make sure to file your return by the due date (or extended due date) to avoid a failure-to-file penalty. If you anticipate receiving a return, you have a little more wiggle room. If you file your tax return after that deadline, the IRS won't impose a failure-to-file penalty. If your return isn't filed within three years of the initial due date, you risk losing your refund.

Failure to pay

You must pay the tax due by the filing deadline, regardless of whether you file your tax return on time or ask for an extension. The IRS assesses a failure-to-pay penalty if your debt is not settled by that time.

The maximum amount of this tax penalty, which is 0.5% of the tax you owe per month, is 25% of the tax payable. The IRS will lower your failure-to-pay penalty to 0.25% of the tax you owe while the installment agreement is in effect if you set up an IRS installment agreement.

Even if you pay the remaining sum before the month ends, failure-to-file and failure-to-pay penalties are assessed for the whole month. When both penalties are applicable in the same month, the failure-to-file penalty is reduced by the failure-to-pay penalty's amount, resulting in a monthly maximum combined failure-to-file and failure-to-pay penalty of 5%.

Pay your tax in full by the tax deadline even if you ask for an extension to prevent or at least reduce failure-to-pay penalties. Pay as much of your debt as you can before the deadline, then make up the difference as soon as you can. Requesting an installment arrangement should be considered if you are unable to pay the remaining balance within a few months of the due date.

Failure to pay proper estimated tax

The IRS uses a "pay as you go" approach, which means you must pay taxes as you earn or get money during the year rather than giving the IRS a sizable flat sum at the end of the year.

When calculating your taxes, if your balance exceeds $1,000, you can be charged a penalty. You should pay taxes throughout the year by having a portion withheld from your paycheck, making anticipated quarterly payments, or doing both.

The IRS determines how much you should have paid each quarter and multiplies the difference between what you paid and what you should have paid by the applicable effective interest rate to determine the penalty amount. This indicates that one quarter can have a penalty but not the others.

Changing the amount of tax withheld from your paycheck or estimating your tax bill and making projected quarterly payments are two ways to prevent or reduce estimated tax penalties. They are normally due on April 15, June 15, September 15, and January 15.

Note: If any of those dates fall on a weekend or legal holiday, the deadline is postponed to the following working day.

To determine whether you are subject to a penalty, the IRS also provides two "safe harbor" procedures. Even if your annual tax bill exceeds $1,000, the IRS won't impose an anticipated tax penalty if you fall under one of these safe harbor levels.

The requirements are that you pay:

90% of your current-year tax liability: Calculate your potential debt, and set aside at least 90% of it in four equal payments or through payroll deduction.

101% of the tax bill from the previous year: Prior to using anticipated payments, withholding, or refundable tax credits, pay the entire amount of tax that was stated on your prior-year tax return. The safe harbor is 110% of your prior-year tax if your adjusted gross income exceeds $150,000 (or $75,000 if you're married and file a separate return from your spouse).

Dishonored check

Your bank may dishonor or "bounce" a cheque you write to pay your tax obligation if you don't have enough funds in your account to cover the amount. Unless the check is for less than $1,250, the IRS assesses a 2% of the check's value dishonored check penalty. The fine in that situation is $25 or the check's value, whichever is lower.

Make sure you have sufficient account balance to cover your payment before mailing a cheque to avoid paying a dishonored cheque fee. Alternately, enroll in overdraft protection with your bank.

Other Types of Penalties That Can Be Levied

IRS audit penalties

There's a significant risk you'll owe more money in taxes if the IRS audits your return and finds errors. Additionally, you can owe numerous fines and interest as a result of this inspection.

These fines are frequently assessed by the IRS as a result of errors on your return. If the IRS thinks you purposely broke the law, you may also be subject to tax fraud penalties.

Ordinarily, the accuracy-related fine is equal to 20% of the underpaid tax. Any of the following grounds could lead to the IRS assessing the accuracy-related penalty against you:

  1. Negligence, including failing to prepare your tax return with the appropriate care
  2. Willful contempt of tax laws
  3. Significant understatement of your income tax obligation
  4. Misrepresenting the property's value materially (gross valuation errors are subject to a 40% fine)

Tax fraud penalties

Tax fraud is the deliberate breaking of tax laws with the goal of avoiding paying taxes. The onus of demonstrating that the taxpayer engaged in tax fraud is on the IRS.

75% of the understated tax is caused by general civil tax fraud. In addition, the taxpayer will be responsible for any unpaid taxes, interest, and possibly further tax penalties.

Another serious penalty for tax fraud is the fraudulent failure to file a penalty. This fine is 15% of the outstanding tax per month, up to a maximum of 75% of the outstanding tax. When a taxpayer has a history of non-filing or somehow demonstrates that they purposefully failed to file their tax returns, this penalty is applied instead of the standard failure-to-file penalty.

Tax evasion penalties

A deliberate attempt to avoid or defeat any tax is known as tax evasion, which calls for a penalty of up to 5 years in prison and a $100,000 fine ($500,000 for a business).

The following are some additional criminal tax penalties:

  1. For submitting a false tax return, there is a maximum 3-year prison sentence and a $100,000 fine.
  2. Willful failure to pay estimated taxes attracts a penalty of one year in prison and $25,000 fine.
  3. For filing a tax return without authorization, you will receive a year in prison and a $25,000 fine.
  4. The _same activities _can result in civil and criminal fines for a taxpayer.

How Does the IRS Calculate Penalty?

Based on how late you file your tax return and the amount of unpaid tax on the initial payment due date (not the extension due date), the IRS determines the failure-to-file penalty. Unpaid tax is the total amount of tax that must be reported on your return less any amounts withheld, paid as estimated tax payments, and credits that are permitted to be claimed as refundable.

The IRS calculates the failure-to-file penalty as explained below:

For each month or portion of a month that a tax return is late, there is a failure-to-file penalty of 5% of the unpaid taxes. The fine will not be more than 25% of your delinquent taxes.

A combined penalty of 5% is assessed for each full or partial month that your return was late if both a failure-to-file penalty and a failure-to-pay penalty were assessed in the same month. The failure-to-file penalty is reduced by the failure-to-pay penalty amount for that month.

The failure-to-file penalty will run out after 5 months if you haven't filed, but the failure-to-pay penalty will continue to run up to a maximum of 25% of the unpaid tax as on the due date until the tax is paid.

The minimum failure-to-file penalty is $435 (for tax returns due in 2020, 2021, and 2022), or 100% of the tax due to be shown on the return, whichever is less, if your return was aging 60 days and above.

Interest on a Penalty

Interest is added to penalties by the IRS. Depending on the kind of penalty, the IRS will start charging interest at a different date. Until you pay off your debt, the applicable interest will keep accumulating. For additional details on the interest on fines, see Interest.

Interest rates for underpayments and overpayments vary and may alter periodically. For extra insights, view Quarterly Interest Rates.

How To Avoid a Penalty

By submitting accurate forms, paying your taxes by the deadline, and providing any information returns on time, you can avoid tax penalties. If you are unable to do so, you may request a payment plan or an extension of time to file.

Apply for an extension of time

Request or apply for an extension of time to file if you need extra time to prepare your tax return. This does not provide you more time to make a payment. You can pay over time with the use of a payment plan.

Apply for a payment plan

If you are unable to pay off your taxes or penalties by the due date, pay what you can now and request for a payment plan. By establishing a payment plan, you could lower future fines.

How To Dispute a Tax Penalty

You may contest the penalty with the IRS if you disagree with the amount you owe.

Write the IRS a letter outlining your case for why they should rethink the penalty, or call them at the toll-free number at the top right corner of your notice or letter. Mail a signed letter together with any necessary supporting documentation to the address provided on the notice.

When you phone or send a letter, have this information in hand:

  • The letter or notification the IRS sent to you
  • The fine you want the IRS to reevaluate (for instance, a 2021 late filing fine)
  • An explanation of each penalty, justifying why you believe the IRS ought to eliminate it

Pay careful attention to see whether the notice or letter the IRS sent you has instructions or deadlines for disputing the penalty. Follow the instructions to successfully dispute a penalty.

Don't hesitate to call for assistance if you didn't receive a notice or letter.

How To Get Tax Penalties Removed

In an ideal world, you wouldn't ever have to worry about IRS fines. Tax penalties, regrettably, are a common occurrence for many people. Thankfully, the IRS frequently agrees to work with individuals who make mistakes. This procedure is called punishment abatement.

Typically, there are two grounds for justifying an appeal to the IRS to reduce penalties.

1. Reasonable cause

Due to exceptional circumstances, the IRS may agree to waive your penalties if you fail to file on time or pay the tax you owe. A house fire, a natural calamity, a disease, or the passing of a close relative are a few examples of justifiable causes.

2. First-time penalty abatement

The IRS may extend a special favor to you if you usually stay on top of your tax filing obligations but recently forgot to file or make a payment. You must meet certain requirements in order to be eligible, including filing all your tax returns, paying any outstanding debt or entering into an installment plan with the IRS, and not having accrued any penalties in the previous three years.

Key Takeaways

  • When it comes to timely filing tax forms and payments, things don't always go as planned.
  • Even with the best of intentions, you may be subject to an IRS tax penalty if you underestimate your quarterly payments, miss a deadline for submitting your taxes, or your IRS check bounces.
  • The failure-to-file penalty will apply if your tax return is not submitted by the due date.
  • The penalty will be reduced by the amount of taxes you didn't pay on time.
  • Additionally, late penalties are subject to interest charges.
  • Errors occur, but it's helpful to understand what types of penalties the IRS imposes and how they are determined. Knowing your choices if the IRS has fined you is also a good idea.