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Common IRS Penalties & How to Avoid Them

common irs penalties and how to avoid them

Owing the IRS doesn’t just stop with your tax balance. If your tax obligations are not met, you could face penalties that can make your debt even more unmanageable. Understanding common IRS penalties and how to avoid them is essential for taxpayers to stay on the right side of the law and minimize financial consequences. Here are some of the most common IRS penalties and how to avoid (or reduce) them.  

Failure to File  

One of the most common penalties imposed by the IRS is the failure to file penalty. If you don’t file by the tax deadline, or the requested extension deadline, and you owe taxes, you will be charged with a failure to file penalty. This penalty is 5% of your unpaid tax for every month or partial month that your return is late. Like the Failure to Pay penalty, it caps out at 25% of your balance. To avoid this penalty, it’s crucial to file your tax return on time, even if you are unable to pay the full amount owed. Filing for an extension can also help avoid this penalty, but it’s important to remember that an extension to file is not an extension to pay any taxes owed. The deadline to file your 2023 tax return is April 15, 2024. 

Failure to Pay  

In addition to the failure to file penalty, the IRS also imposes a failure to pay penalty for taxpayers who do not pay their taxes by the due date. The 0.5% penalty is applied to any unpaid taxes for every month or partial month the tax is not paid. However, it will not exceed 25% of your unpaid taxes. There are some scenarios in which this penalty can increase or decrease. One example is if the IRS sends a notice with an intent to levy. In this case, you have 10 days to pay your taxes. If you do not, the Failure to Pay penalty increases to 1% per month or partial month. However, if you set up a payment plan, the penalty is reduced to 0.25% per month or partial month.   

Underpayment of Estimated Tax  

If you don’t withhold enough taxes throughout the year, you need to make quarterly estimated tax payments. If you don’t pay the correct amount of estimated tax, or if you pay late, you may be penalized. Estimated payments are due every April 15th, June 15th, September 15th and January 15th of the next year. The penalty can change quarterly. As of Q1 of 2024, individuals are charged 8% on underpaid tax while large corporations are charged 10%. You can avoid this penalty by meeting one of two requirements:  

  • Pay 90% of the tax you owe for the current year in four equal estimated payments, or through paycheck withholding  
  • Pay 100% of last year’s tax bill, before withholding or tax credits. If you have an AGI of more than $150,000, you should pay 110%.   

Accuracy-Related Penalties

Taxpayers who file inaccurate tax returns may be subject to accuracy-related penalties. Common reasons for receiving this penalty are if you don’t report all your income or if you claim deductions or credits you don’t qualify for. The two types of this penalty are:  

  • Negligence or Disregard of the Rules of Regulations Penalty: This penalty is common among those who do not follow tax laws or are careless when preparing their return. Examples include not reporting all income or not checking tax deductions that result in a refund that seems too good to be true.  
  • Substantial Understatement of Income Tax Penalty: This penalty is given to those who understate their tax liability by 10% of the tax required to be shown on your return or $5,000, whichever is greater.   

Both of these accuracy-related penalties charge 20% of the portion of underpaid tax that resulted from negligence, disregard, or understated income. Avoiding this penalty is rather simple. Taxpayers should ensure that their tax returns are accurate and complete. Furthermore, they should maintain documentation to support their income, deductions, and credits claimed. 

IRS Penalty Abatement 

Penalties imposed by the IRS can significantly increase the amount owed by taxpayers and can be financially burdensome. However, under certain circumstances, taxpayers may be eligible to have these penalties reduced or eliminated entirely through penalty abatement. Taxpayers may request penalty abatement for reasons such as reasonable cause, statutory exceptions, or administrative waivers. 

  1. Reasonable Cause: One common reason for requesting penalty abatement is demonstrating “reasonable cause.” This means showing that there was a valid reason beyond the taxpayer’s control that prevented them from complying with tax obligations. Examples of reasonable cause may include serious illness, natural disasters, or death in the family, among others. Taxpayers must provide documentation or evidence to support their claim of reasonable cause. 
  1. Statutory Exceptions: Some penalties may have statutory exceptions that allow for penalty relief under specific circumstances. For example, certain penalties may be waived if the taxpayer can demonstrate that they acted in good faith or relied on incorrect advice from the IRS. 
  1. Administrative Waivers: In some cases, the IRS may offer administrative waivers for certain penalties. These waivers are typically granted on a case-by-case basis and may be available for first-time offenders or taxpayers who have a history of compliance with tax laws. 

Penalty relief may be requested via phone or by mailing Form 843, Claim for Refund and Request for Abatement. If the IRS denies your request, you may be able to appeal the decision. 

Get Help Avoiding and Reducing IRS Penalties  

Remember, the IRS charges interest on penalties and interest will continue to increase your balance until it’s paid in full. Since interest on underpayments begin on the tax due date, it’s important to act as quickly as possible to resolve your tax issue. If you can pay your balance in full, you should do so immediately. If you cannot afford to, you should look into options including payment plans or tax relief. Optima Tax Relief is the nation’s leading tax resolution firm with over $1 billion in resolved tax liabilities.   

If You Need Tax Help, Contact Us Today for a Free Consultation 

Ask Phil: Mitigating & Removing IRS Penalties & Interest

Today, Optima Tax Relief’s Lead Tax Attorney, Phil Hwang, discusses penalties and interest again, but this time gives tips on how to mitigate and even remove them.  

Penalties and interest can quickly get out of hand. The best way to mitigate them is to pay your tax liability. We understand that this may not be an option for everyone. If you can’t pay your tax bill in full, you can set up an installment agreement with the IRS. This will reduce your penalty from a 0.5% accrual per month to 0.25% per month.  

Removing Penalties and Interest

If you’re looking to remove your penalties and interest, you have some options. The IRS offers penalty abatement for reasonable cause and first-time abatement. To request penalty relief for reasonable cause, you must prove to the IRS that you tried to file or pay but could not. Examples can include fires, natural disasters, inability to obtain records, death, serious illness, system issues, and some others. It does not include a reliance on a tax profession, lack of ignorance, errors, or lack of funds. 

The IRS also offers penalty abatement by administration waiver, more commonly known as first-time abatement. You can request a first time abate if you failed to file, failed to pay, or failed to deposit. To qualify, you must have a good history of tax compliance and did not have any penalties during the prior 3 years, or a penalty was removed for good reason other than a first-time abatement. 

While interest cannot be removed from your account, it can be adjusted if penalties are abated. Only the interest related to the abated penalty will be reduced or removed. 

Don’t miss next week’s episode where Phil will discuss the Employee Retention Credit. See you next Friday!  

If You Need Help Removing Your IRS Penalties, Contact Us Today for a Free Consultation 

Ask Phil: Penalties and Interest

Today, Optima Tax Relief’s Lead Tax Attorney, Phil Hwang, discusses penalties and interest, including the most common penalties and how interest rates are calculated. 

Failure to File Penalties

Owing the IRS is much more than just owing a tax balance. The IRS also charges penalties and interest, the most common penalties being the Failure to File and Failure to Pay. The Failure to File penalty is charged on tax returns filed after the tax deadline or tax extension deadline without a reasonable cause. It accrues at a rate of 4.5% per month, beginning after taxes are due. For example, if you filed for a tax extension, you have until the usual October 15th deadline to file before penalties and interest begin to accrue. In 2023, the deadline is October 16th. If you did not file an extension, the deadline is April 15th  each year before the Failure to File penalty and interest begin to accrue. In 2023, the deadline was April 18th.   

Failure to Pay Penalties

The Failure to Pay penalty, on the other hand, accrues at 0.5% per month for every month or partial month that a tax balance remains unpaid. The day the Failure to Pay penalty begins to accrue is dependent on whether you filed a tax extension. If you file a tax extension, the Failure to Pay penalty will begin to accrue after the October tax deadline. If you do not file an extension, it will begin to accrue after the April tax deadline.  

IRS Interest Rates

The interest rates on these penalties are calculated based on the federal short-term rate, plus an additional 3%. Interest compounds daily until the balance is paid in full. The interest rates for underpayments in the first quarter of 2024 are as follows: 

  • 7% for individual underpayments  
  • 9% for large corporate underpayments 

Interest rates are determined each quarter. You can find the most up to date news on quarterly interest rates on the IRS website. 

Next week, Phil will discuss IRS enforcement. How long does the IRS have to collect back taxes? Can back taxes affect your credit score? Stay tuned for “Ask Phil” next Friday!  

If You Are Being Hit with IRS Penalties and Interest, Contact Us Today for a Free Consultation