The IRS often imposes penalties on taxpayers who fail to follow the tax rules. These are added on to any back taxes and interest owed. They are intended to punish taxpayers and deter them, and others, from breaking the tax law. The two most common IRS penalties are those for failing to file a tax return and those for underpaying your taxes. These penalties can be steep. But you can often get the IRS to reduce them, sometimes to zero.
Not filing a tax return on time (by April 15 or October 15 if you obtain an extension) is a serious breach of your duties as a taxpayer. Consequently, the IRS imposes a failure to file penalty. The penalty is 5% per month on the amount of taxes you owe, to a maximum of 25% after five months. For example, if you owe the IRS $1,000, you’ll have to pay a $50 penalty each month you don’t file a return, up to a $250 penalty after five months. So, after five months, you’ll owe $1,250.
If you file your return more than 60 days late, you must pay a minimum fine of $210 or 100% percent of the taxes you owe (whichever is less). This means that if the tax due is $210 or less, the penalty is equal to the tax amount due. If the tax due is more than $210, the penalty is at least $210.
If you have unpaid taxes, you’ll also have to pay a failure-to-pay penalty of 0.5% of your unpaid amount for each month the taxes are not paid. This penalty can be as much as 25% of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the IRS reduces the 5% failure-to-file penalty by the amount of the failure-to-pay penalty.
Sounds grim. But there is good news: You may be able to get the IRS to reduce these penalties to zero. Under the IRS first time penalty abatement policy, a taxpayer can get one-time relief from the penalties for failing to file a tax return or pay on time. You qualify for such relief if:
The failure-to-pay penalty continues to accrue until you pay your tax due in full. So it may be advantageous to wait until you fully pay the tax due before requesting penalty relief.
To obtain this penalty relief, call the number on the IRS notice you received informing you that a failure to file or failure to pay penalty was assessed to your tax account.
You can get take advantage of this penalty abatement policy only one time.
If you don’t qualify for the one-time penalty abatement, you can still get your penalty removed if you can show you had reasonable cause for the failure to file or pay on time. For example:
The other common IRS penalty is the accuracy-related penalty. This penalty is imposed on taxpayers who file their tax returns and are later audited by the IRS. The penalty is a whopping 20% of any additional tax owed. For example, if an IRS auditor determines that you underpaid your taxes by $1,000, the accuracy related penalty will be $200. So you’ll owe the IRS $1,200 plus interest.
The IRS most commonly imposes an accuracy-related penalty if it determines:
“Negligence “means you failed to make a reasonable attempt to comply with the tax laws and/or you failed to use ordinary and reasonable care in preparing you return. “Disregard” means you carelessly, recklessly, or intentionally ignored the tax rules and regulations. There is no set amount you must underpay your taxes to be found by the IRS to have acted negligently or with disregard of the rules.
The substantial underpayment penalty applies if you underpay your taxes by the higher of 10% of the amount you should have paid, or $5,000.
Example: Phil files Form 1040 showing a total tax due of $4,000. The IRS audits his return and determines he should have paid $10,000. The understatement of $6,000 is 60% of the amount he should have paid and is more than $5,000. So Phil is assessed a 20% accuracy-related penalty on his $6,000 underpayment. That comes to $1,200.
Getting rid of an accuracy-related penalty is more difficult than if you fail to file a return one time. There is no IRS penalty abatement policy for these penalties. However, that doesn't mean it's impossible to get the IRS to remove them. The general rule is that the IRS can’t impose a penalty if you had reasonable cause for understating your tax and acted in good faith. In other words, you weren't trying to cheat on your taxes. Here are three ways to show this:
You relied on a tax advisor: You hired a competent tax professional to prepare your return, provided him or her with accurate information, and relied in good faith on the tax pro’s advice.
You disclosed your position in your return: If you know your tax return has a high chance for an audit, you can disclose and explain any tax position you took that the IRS might question by filing Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement with your return. If your position had a reasonable basis, the IRS can’t impose a substantial understatement penalty. Obviously, this strategy takes advance planning with your tax advisor.
You have substantial authority: You can also get an accuracy-related penalty removed if you can show you had substantial authority for the position that led to the understatement of tax. This means your position must have been backed up by the tax code, IRS regulations, IRS rulings, court cases, IRS notices, or similar authority.
To contest your penalty, call the IRS at the number on your penalty notice.
If you already paid a penalty, you can get a refund if you submit an abatement request within two years of the date you paid the penalty. File IRS Form 843 to request an abatement.