Penalties Added to Tax Bills
When the IRS hits you with an additional tax bill (from an audit, for example), it usually adds penalties and interest. Penalties are added automatically by IRS computers or by IRS personnel at their discretion. Interest charges are required by law.
Penalties are authorized whenever you file or pay your taxes late, have been found to owe additional taxes, or have failed to file all required tax forms.
Although penalties were originally meant to punish errant taxpayers— that’s why they are called penalties—they are now considered a regular and dependable source of revenue in our national budget. Reflecting this, in the past decade, the total dollar amount of penalties imposed on taxpayers increased by 1,000%. In a recent year, 25 million penalties were assessed for over $6 billion. In short, penalties have become a tax—on a tax.
Take heart—you may be able to beat the IRS at the penalty game
The IRS can remove a penalty if you can show that your failure to comply with the tax law was due to "reasonable cause."
IRS penalties fall into five basic categories—accuracy, fraud, failure to pay taxes, late filings, and a combined late-filing and -paying penalty.
The IRS can add a 20% accuracy-related penalty to your tax bill if IRS auditors find your tax return understated your tax liability. This is a commonly imposed penalty by the IRS “due to negligence or intentional disregard of the tax law.” This means you didn’t pay heed to the tax law or you were just plain careless when filing your tax return.
If the IRS concludes that you fraudulently omitted or underreported income, it can add a heavy fraud penalty. This penalty is up to 75% of the amount you underreported. For example, if you fraudulently underreported $10,000, the maximum fraud penalty is $7,500.
Or, if the IRS finds that you fraudulently failed to file a return, it can penalize you—15% for every month you didn’t file for up to five months—a total of 75% based on the taxes owed. This fraudulent late-filing penalty is rarely, if ever, imposed. Instead, the IRS usually just hits you with a late-filing penalty of 5% per month for a maximum of five months, a total of 25%.
Failure to Withhold, Deposit, or Pay Taxes for Employees
This is a stiff penalty on employers who do not withhold or pay over their employees’ Social Security, Medicare, and income taxes. This happens when employers aren’t timely filing IRS Form 941 and making the deposits. The penalty varies by how late the payments are made.
Failure to File Information Returns
This penalty is on business owners who don’t file reports with the IRS, most often Form 1099 showing payments to service providers like independent contractors. The penalty varies depending on the type of form and the number of nonfiled forms.
Failure to Pay Penalties
The IRS can add to your bill a penalty of 1/4% to 1% per month of the amount you failed to pay on time. The penalty starts off at V2% per month. If you enter into an installment agreement to pay the taxes, the IRS drops the penalty to 1/4% per month. If you don’t pay and the IRS later issues a Notice of Intent to Levy, it can raise the penalty to 1% per month on the balance due.
This penalty starts on the day after the original due date, April 16 for individual tax returns. It is imposed on the unpaid balance and added to your bill on the 16th day of each month thereafter. This penalty is imposed, monthly and is not prorated daily.
Late-Filing Penalties—Late Filing and Late Paying
Did you file your individual tax return late and didn’t request an extension? The IRS can impose a penalty of 5% per month on any tax balance due, up to 25% of the bill. You max out on this penalty if, on September 16—five months and one day after April 15—you still haven’t filed your individual tax return. If you file late but don’t owe any taxes, there is no federal penalty. For some information-type forms (such as 1099s) filed late, the IRS can impose a penalty in varying amounts according to specific tax code provisions.
Did you both file late and pay late? The IRS can impose a combined penalty of 5% per month (1/2% per month less than the separate penalties for each). The combined penalty is based on the unpaid tax balance for each month your return is late. When you reach 25%—five months—for filing late, the penalty for late filing stops. The failure-to-pay portion of the combined penalty continues at 1/2% per month until it reaches a total of 22/2%. Thus, the maximum combined penalty is 47-1/2%. Note that tax penalties do not include charges for interest, which never stops running.
Late-filing penalties, late-payment penalties, or the combined penalty can be stacked—imposed in addition to other penalties, such as accuracy or fraud penalties resulting from an audit of your tax return.
There is hope! Taxpayers that are hit with IRS penalties can request the penalties to be abated. Abated means to completely or partially remove, in many cases where a taxpayer requests abatement, the IRS removes 100% of the penalty. The IRS requires that you have a good reason to request penalty abatement.
What Qualifies as a good reason?
It depends on the circumstances involved with the particular situation. The IRS procedures for deciding who qualifies for penalty abatement and for what reason seem to differin each case. The best thing you can do is to request that the IRS abate your penalties by providing the circumstances surrounding your situation.
You must appeal adverse abatement determinations: the IRS uses an automated tool to help its employees make penalty abatement determinations. This tool is called the “Reasonable Cause Assistant” or “RCA.” The RCA is flawed: it does not consider the totality of the taxpayer’s situation – but summarily rejects penalty relief when one, of possibly many factors, does not meet their standard for abatement. Often, taxpayers must request an appeal so that an appeals officer at the IRS can consider all of the facts and make a correct determination.
There are several solutions that you can employ to get relief from penalties. Which solution(s) you use usually depend on the type of penalty(ies) assessed. IRS collection enforcement (audit, collection, nonfiling) will also determine which avenues are available.
Penalty abatement requests
This is the standard first request for abatement, especially for the failure to file and failure to pay penalties. The format and procedure to file this request will depend on whether the penalty has been paid or the taxpayer still owes the penalty. This request outlines the specific taxpayer’s circumstances and reasons that were outside of their control that caused them to not comply. Responses usually come within 4-8 weeks from the IRS. Adverse requests should consider appeals so that a person at the IRS considers all of the taxpayer’s circumstances.
IRS Service Center Penalty appeals
If a taxpayer gets a relief denial determination for the failure to file penalty and the failure to pay penalty, the first course of action is to appeal to the IRS. Taxpayers have 60-days to appeal the adverse determination with the IRS Service Center Appeals Coordinator. 3-4 months after the appeals request has been sent, taxpayers receive an informal phone to argue their case with an IRS appeals officer.
Collection Due Process (“CDP”) appeals
If a taxpayer does not pay their penalty, they can request a more formal CDP hearing after the IRS sends a notice of intent to levy or files a tax lien. A timely CDP hearing request (uses IRS Form 12153) will result in a hearing with an appeals officer in about 8 weeks. CDP hearings are good venues to argue penalties because the IRS must provide any adverse determination reasons in writing. This formal process affords the taxpayer the right to contest these findings in court.
Audits/CP2000s and the accuracy penalty
If the taxpayer is assessed an accuracy penalty (negligence, substantial understatement, and/or civil fraud), the avenue to first contest the penalty is with the IRS auditor or IRS unit that is proposing the penalty. The taxpayer must show how they made a reasonable attempt to file an accurate return. If the auditor disagrees with the taxpayer and still proposes the penalty, the taxpayer has the option to contest the penalty determination with the IRS office of appeals before the penalty is assessed. If the taxpayer does not contest this penalty, the IRS will assess the penalty and the taxpayer will have two alternatives to “undo” the accuracy penalty assessment: request reconsideration (audit or CP2000) or pay the penalty and file a claim for refund with the IRS. Many claims for refund are not successful in abating the accuracy penalty unless the taxpayer is willing to take the IRS to court to contest the penalty.
Need help with a penalty or want to know if you have past penalties that can be abated? Contact us today.