Many people find that filing taxes can be complicated and confusing. Hiring an accountant or tax preparer to help is one way to cut down on the confusion. However, even if someone else completes the tax documents, the taxpayer is still ultimately responsible for the information provided, when the paperwork is filed, and whether the appropriate amount of taxes has been paid. Even a simple mistake can leave a taxpayer with a penalty from the Internal Revenue Service (IRS). If you have been assessed one of the many types of IRS penalties or received a notice from the IRS, consider contacting Damiens Law at (601) 957-9672 to learn more about your options.
Why does the IRS charge penalties?
According to the IRS Internal Revenue Manuals Penalty Handbook (126.96.36.199.2), the IRS charges penalties to ensure voluntary compliance with paying taxes. Voluntary compliance is preparing an accurate tax return, filing it on time, and paying any taxes that are owed. Penalties define standards of compliance, set consequences for failing to comply with those standards, and penalize taxpayers who fail to meet them.
How are penalties assessed?
The amount a taxpayer will be expected to pay for a penalty depends on the penalty itself. Penalties are assessed in different ways. Some are assessed as a flat rate plus interest. Others are a percentage of the amount of tax the taxpayer owes. Some penalties come with more complicated calculations that include the amount owed, the period the taxes were owed, and interest rates that the IRS publishes quarterly. Most penalties include interest as well.
What types of IRS penalties does the IRS charge?
From 14 penalties in 1955 to over 10 times that number now, the IRS has many types of penalties for charging taxpayers when they fail to comply with tax obligations. However, not all options are frequently used. The penalties most commonly charged to taxpayers are related to filing accurate returns and paying taxes on time. Whether a taxpayer receives one or more of these penalties or one of the lesser-known penalties, he or she can bring the notice to Damiens Law to learn more about the penalty and his or her options.
Failure to file a timely tax return
This penalty is one of the most common. A taxpayer will be charged this penalty if he or she fails to file a tax return by the established deadline and has not filed an extension to request more time to file the tax return. The taxpayer may also face a failure to pay penalty if taxes owed are not paid due to not filing the tax return.
Failure to file a timely information return
This late filing penalty applies to people who hire others during the year. An information return is a form, such as a W-2 or a 1099, that a business owner is required to provide to employees or contractors. No taxes are paid on these forms, but they provide the information needed for employees or contractors to file their own taxes. If these forms are not filed by their deadline, the business owner will be charged a late filing penalty for a set amount per form not filed.
Accuracy-related penalties apply when a taxpayer underpays the required amount of unpaid tax. This penalty can be assessed due to the taxpayer underreporting income or taking deductions that the taxpayer is not qualified to take. There are two accuracy-related penalties that can apply:
- Negligence or Disregard of the Rules or Regulations—Applies to taxpayers who intentionally, carelessly, or recklessly ignore the tax rules or regulations and make no reasonable attempt to follow them.
- Substantial Understatement of Income Tax—Applies to taxpayers who understate their tax liability by 10 percent or $5,000, whichever is greater, of the tax they would otherwise be required to pay.
This estimated tax penalty is assessed when a taxpayer provides a check or electronic payment to pay taxes, fees, or fines, and the bank does not honor the payment because there is not enough money in the account. If assessed this penalty, the taxpayer will still need to pay the original amount due plus a percentage of the original amount due as the penalty.
Underestimated or late payments
This penalty can apply to both individuals and corporations. Taxpayers are required to estimate and pay quarterly taxes on the income they predict they will earn if they do not work for an employer that withholds taxes. If a taxpayer underestimates this amount, he or she can be charged a penalty (even if owed a refund). Late payments apply when a taxpayer files a tax return but fails to pay the taxes owed, or if the IRS determines that the taxpayer failed to report tax owed on the tax return. Failure to pay or accuracy-related penalties may also apply.
Failure to deposit withholding taxes
This penalty applies to employers who are required to pay employment taxes. If an employer fails to pay federal income tax, Social Security and Medicare taxes, and/or Federal Unemployment Tax in the right amount at the right time and in the right way, the employer can be charged a penalty for failure to deposit withholding taxes.
Tax advisor penalties
Tax advisor penalties apply to anyone, professional or not, who is paid to prepare a tax return and does not follow the rules and laws of tax preparation. A tax advisor can be charged with several penalties, including providing fraudulent information on the tax return or promoting abusive tax shelters. If the advisor can correct the information noted in the penalty notice sent from the IRS, he or she may be able to avoid a penalty.
This penalty applies to taxpayers or tax preparers who make false statements on tax returns or prepare fraudulent returns or other tax documents. If assessed this penalty, taxpayers are charged a fine and can also be charged with a misdemeanor or felony crime by theDepartment of Justice and face prison time.
How can taxpayers get relief if they are charged a penalty?
If charged with one of the several types of IRS penalties, taxpayers do have methods of finding relief. Depending on the penalty, taxpayers can try one of the following options.
Reasonable cause means that the taxpayer intended to meet the federal tax obligations and was doing everything within his or her control to do so but circumstances outside the taxpayer’s control prevented compliance on the tax owed. It is important to note that the lack of money to pay the taxes by itself is not considered a reasonable cause. However, the reason for the lack of money may be considered reasonable cause if it falls under one of these examples:
- Serious illness
- Natural disaster
- Inability to obtain records
- Other reason showing that the taxpayer was doing everything possible to meet the obligations but, nevertheless, could not
Statutory exceptions apply when a taxpayer is assessed an unpaid tax penalty based on erroneous written advice directly from the IRS. To prove a statutory exception, the taxpayer will need to provide:
- The original written request for advice
- The erroneous written advice that was provided by the IRS
- The tax adjustment report, if the taxpayer has one, that identifies the penalties charged or tax addition, as well as the item(s) related to the incorrect advice
In certain circumstances, taxpayers may be eligible for an administrative waiver under the IRS’s First Time Penalty Abatement policy. This policy only applies to a taxpayer’s failure to file a tax return, failure to pay taxes owed on time, or failure to deposit taxes when due. It also only applies if the taxpayer:
- Did not previously need to file a tax return or
- Has had no penalties for the three tax years prior or
- Has filed all currently required returns or filed for an extension or
- Has paid or made arrangements to pay any taxes due
TheIRS does recommend that taxpayers wait until the unpaid tax owed has been paid before requesting penalty relief under the abatement policy for a better outcome. Additionally, if a taxpayer received incorrect oral advice from the IRS, he or she may be eligible for administrative relief.
Correction of Service Error
Correction of Service Error applies when the IRS makes a mistake in determining that a taxpayer did not comply with their tax obligations when the taxpayer did, in fact, comply. This may be a computer error, or an error made by a human being. Possible errors include but are not limited to errors in computing or assessing taxes, crediting accounts, manually computing a failure to file penalty, and making a math error, or not properly filing an extension that the taxpayer filed. Additionally, this correction can apply to any error where the taxpayer can prove that he or she did comply with the law, but the IRS initially failed to recognize the compliance.
How can taxpayers avoid penalties?
Taxpayers do have options that can help them avoid paying penalties. These options need to be exercised quickly and may include additional fees, but they give taxpayers more time to file and/or pay.
Apply for an extension
If a taxpayer knows that he or she will not be able to file a tax return by the deadline, the taxpayer can avoid penalties by filing for an extension of time to file. Taxpayers must file this request by the original deadline. They can also avoid penalties by estimating and paying any owed taxes.
Filing an extension will give the taxpayer until October 15 of that year to file. However, it also requires the taxpayer to estimate and pay any tax liability along with the extension form. This extension only gives taxpayers more time to file; it does not give them more time to pay the taxes owed.
Apply for a payment plan
When a taxpayer knows he or she cannot pay the amount of taxes owed in full immediately, the taxpayer can apply for a payment plan. The application requires approval from the IRS, and the taxpayer will need to meet specific requirements. This option allows the taxpayer to make monthly payments until the taxes are paid in full. A short-term payment plan does not involve any setup fees, but long-term payment plans do have setup fees.
If the taxpayer chooses to pay with a credit or debit card, additional fees will be involved. While setting up a payment plan can prevent new penalties, the taxpayer will be required to pay accrued penalties and interest as part of the balance included in the payment plan.
Do not let penalties add up
Even with the most careful math and multiple checks over the information provided, mistakes can happen, and taxpayers can end up facing one or more of the types of IRS penalties that exist today.