Understanding IRS Tax Penalties

Even the least tax savvy of Americans probably knows one thing about the IRS: if you screw up on your taxes you are going to have to pay more money.

Unfortunately, there are a lot of ways to “screw up” your taxes, especially if you own a business. And sure enough, the first time you make a mistake is probably just when the IRS will decide to audit you. No one wants to pay more than they have to on their taxes just because they accidentally neglected to include some income, not to mention the penalties associated with underpaying the IRS or not filing on time, as well as the possibility of criminal charges for things like tax evasion.

But exactly how much more are you going to have to pay for these tax slip-ups? Below we’ve detailed how the IRS calculates penalties for several common situations.

Late filing penalties

If you owe the IRS taxes and you fail to file on time, then you will face some stiff penalties in addition to still owing the taxes you haven’t paid and interest. The late filing penalty will be 5% of the unpaid taxes for every month your taxes are not filed for up to five months (or 25% of your unpaid taxes). So, on top of the taxes you owed anyway, you could pay up to a quarter of those taxes more in penalties for filing after the tax due date.

Late payment penalties

There are still penalties involved in underpaying one’s taxes, but as long as you file on time and pay some of your tax bill the consequences will not be as stiff as those for filing late. Known as the “failure-to-pay” penalty, you will owe 0.5% of the remaining unpaid taxes each month until the taxes are paid off. However, unlike the late filing penalty, there is no limit to how many months you could be charged this 0.5% fee. If you owe both the late filing and the failure-to-pay penalty at the same time, you will only pay a maximum of 5% of your unpaid tax bill.

Accuracy penalties

If you file inaccurate tax returns, there is a somewhat subjective line involved where the IRS will make a determination of whether or not you made a negligent (unreasonably careless) mistake or you actively committed tax fraud based on the severity of the mistakes and other factors. If you make a mistake on your tax returns that benefits the IRS, there will be no penalties. However, if you make mistakes beyond simple math errors that allow you to pay significantly less in taxes than you should legally owe, you could face serious penalties. If you underpaid by either 10% of what you should have owed, or $5000 less than what you owed (whichever is more), You will be subject to a flat fee of an addition 20%. This penalty can also apply if you are found during an audit to have broken IRS rules or kept inadequate records. If the IRS determines your tax “mistake” was actually tax fraud, your penalty will jump to 75% and you will be subject to criminal penalties as well.

Don’t forget, on top of these three penalties you will also have to pay interest on any unpaid taxes. Mistakes on your tax returns can be wildly costly and devastating for your business. Your best defense against making errors and facing serious penalties is up-front tax planning. Call Morgan Maxwell to discuss how an experienced tax defense attorney can help you build a customized plan to protect your business from the imposition of tax-related penalties.

Written by E. Morgan Maxwell

E. Morgan Maxwell

Since beginning his own firm, Mr. Maxwell has continued a tax-law oriented practice encompassing a wide range of transactions, planning and dispute resolution. His dispute resolution experience includes involvement at all levels of the Internal Revenue Service (Examinations, Appeals, Collections, Office of Professional Responsibility, the U.S. Tax Court), the Pennsylvania Department of Revenue, the Tax Litigation Section of the Pennsylvania Attorney General’s Office, Pennsylvania Commonwealth Court, Common Pleas Court and local taxing jurisdictions in southeastern Pennsylvania.

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