What’s the Deal with IRS Penalties?

by Tom Buck

IRS penalties can be draconian. The penalties that are applied most often have to do with late filing and late payment of taxes due. Individual tax returns must be filed by April 15th each year (although this year we have until April 18th because one of the states observes Friday, April 15th as a legal holiday, so everyone in the country gets an extra three days to file this year). It is always possible to get a six month extension of time to file (not to pay), but the request must be filed by April 15th.

If you are one day late AND you have a balance due on the return, the penalty is 5% of the amount due. For every additional month you file late another 5% is added to the bill. This goes on for a maximum of five months. You can do the math and realize that if the return is filed five or more months late the penalty is at least 25%.

For every month after five months there is a penalty of 0.5% (or 6% per year) added. On top of the penalties, the IRS also adds interest at the current rate of 3% per year. This interest is calculated not only on the tax due, but also on the penalties AND it compounds so you end up paying interest on the interest as well.

Unfortunately, it is not uncommon for us to take on clients who have not filed for several years and owe taxes for every year. You can see how the penalties and interest could easily cause the tax bill to double because of penalty and interest additions. We regularly talk with taxpayers who tell us they could pay the IRS if it were not for these add-ons.

If you have a good reason for not filing on time (think major medical issues or something as serious) it is possible for the IRS to agree to abate some or all of the penalties. The interest is almost NEVER able to be abated, regardless of the reason for late filing.

On this subject there is a small amount of good news. For the first year you file late (assuming you have filed and paid each of the previous three years on time) there is a program called the First Time Abatement. IRS will forgive the penalties for late filing or late payment for that one year only.

On the subject of late filing, the IRS has begun penalizing partnerships (form 1065 filers) and Sub-chapter S Corporations (form 1120-S filers) for late filing. In case you are not aware, these two forms of organization NEVER have any tax liability because the results of their operations are reported on the tax returns of the individual owners.

The penalties for late filing presently (they have been regularly increased since they were first instituted) are $195 for each month of late filing up to a maximum of twelve months, for each owner. That comes out to $2340 in penalties, times however many owners there are.

It is not uncommon for husband and wife to both be owners. That means $4680 per year if the returns are filed more than twelve months late. If there are more owners, this penalty can become huge. Of course, as with all penalties, interest continues to accrue on the penalties.

For both of the above late filing penalties, the word to the wise is: “do not file late”. It is much better to file on time even if you can’t pay the tax due because you dramatically reduce the penalties. The late payment penalty is only 0.5% per month, not 5% per month. You can also arrange to make payments on any amount due with a form that is filed with your tax return. Your preparer can help with this.

The other most common penalty results when the IRS audits a return and comes up with $5000 or more additional tax due as a result of the audit. This is called a “negligence” penalty even though in many cases the taxpayer has not been “negligent”, but only made an honest mistake. The amount of the penalty is a flat 20% of the additional tax due.

There are myriad other penalties that the IRS is able to apply, but the ones outlined here are those that catch the most people and are some of the more costly ones. Try to file and pay on time and be as honest as you can so the IRS doesn’t have a chance to hit you with the negligence penalty in the event of an audit.

Remember us if you or others you know are having ANY problems with the IRS. We protect our fellow citizens against their government by making sure the IRS obeys the rules.