The Internal Revenue Service (IRS) imposes tax penalties when a taxpayer does not comply with its tax obligations in a timely manner. The amount of the penalty will depend on the type of tax obligation that the taxpayer failed to comply with and on the amount of taxpayer’s outstanding tax liability. These penalties are imposed to encourage and promote taxpayers to timely comply with their tax obligations. However, the IRS is aware that sometimes taxpayers may be going through situations in their life that prevents them from timely complying with their tax obligations. For that reason, the IRS has made available penalty reliefs which can help taxpayers get certain penalties waived. Below is a list of the type of penalties that the IRS assess to taxpayers and the type of relief available to have a penalty abated.
Failure-to-File penalty: is a penalty assessed to a taxpayer when the taxpayer does not file its tax return by the filling deadline. This penalty is calculated based on how late the tax return is and how much tax liability is outstanding by the original filling due date, which for an individual usually is by April 15 after the calendar year ends. The penalty assessed by the IRS is 5% of the unpaid tax liability for each month or part of the month that the tax return is late. For tax returns that are over 60 days late, the minimum Failure to File penalty is the lesser of $435 or 100% of the tax required to be shown on the return.
One way to avoid this type of penalty, is by filling an extension by the original filling due date which gives the taxpayer an extra 6-month extension to file its tax return. However, the taxpayer needs to be aware that for the extension to be valid, the taxpayer needs to have paid at least 90% of its tax liability by the original due date. The taxpayer also needs to note that the 6-month extension is only an extension to file and not an extension to pay.
Failure-to-Pay penalty: is a penalty assessed when a taxpayer fails to pay any outstanding tax liability by the original filling due date. The penalty assessed by the IRS is 0.5% of the unpaid tax liability for each month or part of the month that the tax remains unpaid. If, a taxpayer knows that he or she will have an outstanding tax liability and that he or she will not be able to make the payment in full by the due date, the taxpayer might be able to reduce the tax penalty assessment percentage form the 0.5% to the .025%. The taxpayer can do this by making sure to file its tax return on time and by setting up a payment plan with the IRS before the due date.
Estimated tax penalty: If, a taxpayer believes that the amount of tax withheld from their paychecks will not be enough to cover its tax liability or if a taxpayer does not have any tax withholding from its earned income, then the taxpayer is required to make quarterly estimated tax payments during the year to cover its tax liability. If, these quarterly payments are not made or if the amount of quarterly payments made is not enough, then the IRS will assess an estimated tax penalty. The IRS asses this type of penalty to promote taxpayers to make accurate and on time estimated tax payments.
This type of penalty can be avoided by paying at least 90% of the total tax shown on the tax return for the current taxable year or by having 100% of the tax shown of the prior year, or 110% for higher earning taxpayers.
Accuracy-Related Penalty: is assessed when a Taxpayer does not pay the total tax required to be shown on their filed tax return. There are two types of accuracy-related penalties that the IRS can assess to individual:
- Negligence or Disregard of the Rules or Regulations Penalty which is assessed when a taxpayer does not make a reasonable attempt to follow the tax laws when preparing their tax return. Example of this include:
- Not keeping records to prove that the taxpayer qualifies for the credits or deductions claimed on the tax return
- Not including all the income required to be included in the tax return
- Substantial Understatement of Income Tax Penalty is assessed when a taxpayer understates its tax liability by 10% of the tax required to be shown on the tax return or $5,000 whichever is greater.
As previously mentioned, the IRS has some tax penalties reliefs available for taxpayers. The following are the tax penalties relief available.
First-time penalty abatement: This penalty relief is available for Failure-to-File and Failure to Pay penalties. This penalty abatement applies only for one tax year/ period and to qualify for this abatement, the taxpayer must meet the following conditions:
- The taxpayer didn’t previously have to file a return or had no penalties for the 3 tax years prior to the tax year in which the taxpayer received a penalty.
- The taxpayer filed all currently required returns or filed an extension of time to file.
- The taxpayer has paid, or arranged to pay, any tax due
This type of penalty abatement request can be made to the IRS by writing in a letter explaining why the taxpayer qualifies for the penalty abatement or by calling directly to the IRS and explaining over the phone why the taxpayer qualifies for the penalty abatement.
Reasonable cause abatement: This penalty is based on the facts and circumstances of the taxpayer. The IRS will consider any reason which shows that the taxpayer used all ordinary business care and prudence to meet with its federal tax obligations but due to certain circumstances was not able to do so. Some of the most common reasons that the IRS will accept are:
- Fire, casualty, natural disaster or other disturbances
- Inability to obtain records
- Death, serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family
- Other reason which establishes that you used all ordinary business care and prudence to meet your federal tax obligations but were nevertheless unable to do so
The type of documents and proofs needed to provide to the IRS for a penalty abatement due to reasonable cause depends on the type of penalty being assessed and, on the situation, surrounding the taxpayer reasons for not being able to comply with its tax obligations.
Statutory Exception abatement: This penalty abatement is granted to a taxpayer who received incorrect written advice from the IRS. If, a taxpayer believes that they were assessed a penalty as a result of an erroneous written advice received from the IRS, the taxpayer may request penalty relief of the penalty by providing the following information:
- The written request for advice
- The erroneous written advice relied on that was furnished by the IRS
- The report of tax adjustment identifying the penalty and the items relating to the erroneous advice
Being informed of the types of penalties that the IRS can impose and the types of reliefs available can keep the taxpayer informed of the options and tools available to reduce any outstanding balance due which includes any type of the above-mentioned penalties. Therefore, when receiving a notice or bill from the IRS reach out to a tax professional to see if there are any possibilities to reduce or eliminate any outstanding balance. Keep in mind that is always worth requesting for a penalty abatement. The worst that can happen is that the IRS denies the penalty abatement request and having to pay full amount due in the notice.
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