IRS Tax Penalties

One of
the most dreaded times of the year for many Americans rolls around on April 15th of each year with the deadline for filing income tax returns. Sometimes it is extended if the 15th lands on a Saturday or a Sunday, but most of the time, you’ve got to have your taxes filed (or an extension) by the 15th of April. The prospects for filing
this year may be even dimmer for many due to the current economic downturn and
worsening financial and employment conditions.

This
article provides a quick reference guide to the various potential consequences
of not filing a return or paying income taxes due in a timely and accurate
manner. In-depth information on each penalty follows below, or just click on
the links to jump to more information.

Timely Filers Who Do Not Pay Total Due: one-half of 1% of the tax
owed for each month until tax is paid (25% maximum)

Late Filers: 5 percent of the tax owed for each month
late (up to 25%); increased penalties for fraud

Combined Penalties: if both of the above apply): the
failure-to-file penalty minus the failure-to-pay penalty

Frivolous Tax Submissions: $5,000 penalty

Mistakes: 20% of the underpayment

Civil Fraud: 75% of the underpayment

Criminal Penalties: civil fraud penalty (75%), plus substantial
fines and jail time

Interest: for all late or under-paying filers,
interest will compound daily on their unpaid taxes at the federal short term
rate plus 3%

Timely Filers Who Do Not Pay the Full Amount Due

If
someone files on time but doesn’t pay the full amount they owe on time, they
will usually have to pay a late payment penalty of one-half of one percent of
the tax owed for each month, or part of a month, that the tax remains unpaid
from the due date, until the tax is paid in full or a 25% maximum penalty is
applied. The one-half of one percent rate increases to one percent if the tax
remains unpaid 10 days after the IRS issues a notice of intent to levy.

In
some cases, it is not a bad idea to negotiate an installment agreement with the
IRS to pay off back taxes. For individuals who file by the return due date, the
one-half of one percent rate decreases to one-quarter percent for any month in
which an installment agreement is in effect.

Late Filers

Faced
with the above penalties, some might choose to take a
bury-your-head-in-the-sand approach to filing a tax return in the first place.
However, the penalties for not filing at all or filing late are notably worse
than those above.

The
total late-filing penalty is usually 5 percent of the tax owed for each month,
or part of a month that your return is late, up to five months (or 25% of the
amount shown due on the return). Also, if a filer’s return is over 60 days
late, the minimum penalty for late filing is the smaller of $100 or 100 percent
of the tax owed.

Finally,
if the tax payer’s failure to file is due to fraud, the penalty is 15% for each
month or part of a month that the return is late, up to a maximum of 75%.

Combined Penalties

If
both of the aforementioned failure-to-file and failure-to-pay penalties apply
in any month, the 5% (or 15%) failure-to-file penalty is reduced by the
failure-to-pay penalty. However, if you file your return more than 60 days
after the due date or extended due date, the minimum penalty is the smaller of
$135 or 100% of the unpaid tax.

Frivolous Tax Submissions

Often
suffered by “tax protesters” or those who adopt their arguments, the
IRS may assess a penalty of $5,000 if someone files a frivolous tax return or
other frivolous submission. A frivolous tax return is one that does not include
enough information to figure the correct tax or that contains information
clearly showing that the tax reported was substantially incorrect.

Individuals
unsure about a particular tax strategy they are considering should take a look
at this information from the IRS on frivolous returns, frivolous submissions,
and a list of positions that are identified by the IRS as frivolous: “The
Truth About Frivolous Tax Arguments”.

Mistakes

You
may have to pay a penalty if you file an erroneous claim for refund or credit.
This occurs in circumstances where a taxpayer:

Shows negligence
or disregard of the rules or regulations, or
Substantially
understates their income tax.

The
penalty is equal to 20% of the underpayment, unless the taxpayer adequately
discloses a reasonable basis for the way they treated the item at issue, or
their position was supported by substantial authority. 26 U.S.C. section 6662.

Civil Fraud

The penalties
get significantly worse for intentional underpayments. If there is any
underpayment of tax on your return due to fraud, a penalty of 75% of the
underpayment due to fraud will be added to your tax. 26 U.S.C. section 6663.

Criminal Penalties

All of
the above fall into the category of “civil” penalties, but the most
severe penalties filers face are directed toward those who commit tax evasion,
fraud, and similar offenses. Individuals who get caught committing tax fraud
face the above noted 75% civil penalty, and additionally face substantial fines
and jail time.

For
example, attempting to evade or defeat tax under is a felony carrying a fine of
up to $250,000 and imprisonment for up to 5 years. 26 U.S.C. section 7201.
Making false statements on a tax return is also a felony risking the same fine
and imprisonment for up to 3 years. 26 U.S.C. section 7206. If you are being
investigated for a tax crime by the IRS, it is very important to retain an
attorney who is familiar with both tax and criminal matters.

Interest

Although
not a “penalty” in the traditional sense, a late filer or taxpayer
who does not pay the entirety of the amount they owe will have to pay interest.
Interest is charged on the amount of unpaid balance, penalties, and interest
that has been charged to the tax account from the due date of the return until
the date payment is made. The interest rate is determined every three months
and is the federal short-term rate plus 3 percent. Furthermore, interest is
compounded daily.

With
this in mind, it should be noted that in many cases, the funds necessary to pay
taxes can be borrowed at a lower effective rate than the combined IRS interest
plus penalty rate.