IRS penalties

By Andrew D. Schwartz, CPA Schwartz & Schwartz, P.C., Woburn, MA

Some compare it to adding salt to a wound. Others see it as adding insult to injury. And many feel like they're being kicked when they are down.

I am referring to paying IRS penalties. For many people, paying the taxes owed every year is painful enough. But getting hit with IRS penalties can push even the most mild mannered taxpayer over the edge. Let's take a look at some of the more commonly incurred penalties.

Late Filing Penalty:

How does a 5% penalty per month on any outstanding tax balance sound to you? $50 per month on every $1,000 owed is what the IRS charges if you fail to file your tax return, or an extension request, by the tax return's due date. The good news is that the maximum failure to file penalty is capped at 25% of the unpaid balance.

The moral of this story is simple. Even if you can't pay all the taxes you owe by the filing date, make sure to submit the paperwork or extension request on time.

Late Payment Penalty:

The late payment penalty is a lot more reasonable than the late filing penalty. The IRS will assess a penalty of 0.5% per month on any taxes owed, provided you file the paperwork or extension requests on time. The clock starts ticking as of the due date of your tax return (including extensions if the amount you owe is small enough).

It's very important to always file an extension request with the IRS if you can't complete the tax return on time, since filing the one-page extension ensures that you'll avoid the 5% per month late filing penalty. And if you have 90% of your tax liability paid in by the due date of the return, or owe less than $1,000 with your return, expect to avoid the late payment penalty as well.

Like the failure to file penalty, the late payment penalty is limited to 25% of any unpaid taxes. And if you get hit with both penalties, your combined penalty won't exceed 5% per month and 25% of the total taxes owed.

Underpayment of Estimated Taxes:

Being late with your estimated taxes or not having enough taxes withheld is the cheapest money you can borrow from the IRS. Expect to be assessed an underpayment penalty if you owe more than $1,000 with the filing of your tax return and don't meet certain other exceptions. These exceptions include paying in 90% of your current year's tax liability or 100% (110% for high income taxpayers) of your prior year's liability.

Since the rate for this penalty is based on the prevailing market interest rates, it's been running at only 4%-5% in recent years. For many people, the rate charged by the IRS for this penalty is one-third or less of the rate charged on their credit cards.

Accuracy Related Penalty:

If the IRS makes changes to your tax return, either through an audit or through its matching program, and determines that you understated your taxes by the greater of 10% of the corrected tax or $5,000, they will automatically assess a penalty of 20% of the underpaid tax. You might also get hit with this penalty for failing to keep adequate records to substantiate your tax return.

Getting Penalties Waived:

What happens if you get assessed one of these penalties? You have the right to request that the IRS waive the penalties for "reasonable cause". In most cases, it makes sense to draft a letter explaining why you either missed a deadline or owed so much in taxes that you got hit with a penalty. Chances are pretty good that if it's your first or second offense, the IRS will give you the benefit of the doubt and waive the penalty.