A Guide to IRS Tax Penalties & Interest

Every taxpayer has to meet certain responsibilities, including filing returns and paying taxes on time. Failing to meet these responsibilities can attract charges with multiple tax penalties. The Internal Revenue Service (IRS) is the agency responsible for tax collection and enforcement of tax laws in the US.

The IRS assesses some penalties when you miss a deadline or fail to pay your tax bill on time, as required—the process is automatic. However, the agency may assess other penalties if you knowingly commit tax fraud or tax evasion.

Here are some tax penalties and interest the IRS can charge you.

Penalties and interest for underpayment of estimated taxes

Income for some taxpayers, such as independent contractors and self-employed individuals, is not subject to withholding. As a result, they have to estimate their tax payments throughout the year.

Since they have uneven income, they make unequal payments during the year, unlike other taxpayers who make payments in equal quarterly installments.

However, you may be charged underpayment penalties and interest if you don’t make estimated payments or don’t pay enough. The IRS will calculate the penalties based on the length and amount of the underpayment.

Also, the IRS can charge you the underpayment penalty if you’re a taxpayer with W-2 income but lack enough taxes withheld. While the IRS may work out your penalty amount and send you a bill, you can figure it out using Form 2210.

Can you avoid underpayment penalties?

Here’s what you need to do if you don’t want the IRS to ever charge you underpayment penalties;

• Pay at least 100% of the previous year’s total tax liability in estimated taxes in the current year.
• Pay at least 90% of the current year’s total tax liability in estimated taxes in the current year.
• The IRS won’t charge you underpayment penalties if you owe less than $1000 in taxes for the whole year.

Penalty for filing late returns or failing to file returns (Failure to file penalty)

Some taxpayers file their returns late or fail to file returns because they can’t pay their entire tax bill. However, you should always file your returns by the due date, regardless, to avoid the late filing penalty.

If the IRS charges you a late filing penalty, you’ll need to pay 5% of your monthly unpaid taxes. However, the penalty will never exceed 25% of the tax owed.

If your returns are over 60 days late, you’ll be charged a minimum Failure to File Penalty of $210, or 100% of the unpaid taxes, whichever is less.

You can agree to pay off your unpaid taxes in installments with monthly payments to avoid the Failure to file Penalty. Additionally, you can ask for an automatic filing extension, usually for six months, to avoid the penalty.

However, if you fail to file a federal tax return, the IRS may file it on your behalf—known as a substitute for return (SFR). This is based on the information from your banks, employers, and other payers. The SFR doesn’t include tax credits or deductions you may be eligible to receive. Generally, the IRS assesses tax at a higher amount when they file an SFR.

After filing the SFR, the IRS may try to collect the taxes using wage garnishments, bank levies, and tax liens.

Interest Rates for Underpayment or Non-payment of Taxes

The IRS sets underpayment interest rates each quarter. Individual taxpayer interest rates are calculated by adding three percentage points to the federal short-term rate. The interest compounds daily-currently the rate stands at 7%.

The IRS charges interest on unpaid or late taxes, regardless of the cause. This means if you don’t pay enough taxes or pay late by a day, you’ll be charged interest. The IRS can only grant interest abatement (in rare cases) if it has made an error.

IRS Audit Penalties

During the tax audit process, the IRS may examine your tax return. If it does, you may owe additional taxes. The examination may also give rise to various interests and penalties. The IRS can randomly select you for an audit or select you when you make an error on your IRS forms.

The IRS will send you a notice before auditing you. There’s no set time limit for the IRS audit—the process begins when you receive a notice.

Mostly, the IRS will charge you audit penalties due to inaccuracies on your return. Moreover, if the IRS believes you intentionally went against the tax laws, you could face fraud penalties.

IRS audit penalties vary based on the scale of your tax problem. But generally, you could face a 20%-40% penalty if you made an error on your tax return. If the audit finds more serious cases like fraud, you could be charged a 75% penalty.

Additionally, the IRS may seize your assets or send you to jail (if you attempt to escape with criminal tax evasion).

However, not all IRS audits will result in a penalty. The IRS will only charge you if their audit gives them reasons to. Therefore, you should always keep accurate and organized records, just in case of an IRS audit.

Accuracy-related penalties

The IRS charges an accuracy-related penalty of 20% of the understated tax. Underpayment may occur if you fail to report all your income or claim credits and deductions you don’t qualify for.

Here are some reasons you could be charged with an accuracy-related penalty.

•  Understating your income tax liability substantially—if you understate your tax liability by 10% of the tax to be displayed on your tax return or $5,000, whichever is greater.
• Negligence—this includes failing to prepare your tax returns properly and not keeping records to prove your qualifications for claimed deductions or credits.

•  Intentional disregard of the tax laws
• Substantially misstating your property’s value (this may attract a 40% penalty for gross valuation misstatements)

The IRS will send you a letter or notice if you owe an accuracy-related penalty.

Tax fraud penalties

You commit tax fraud if you intentionally violate the tax laws to avoid paying taxes. However, the IRS must prove that you committed tax fraud in order to impose the penalties. Therefore, IRS investigators will look for the following to prove tax fraud;

•  Using a false social security number
•  Underreporting income
•  Falsifying documents
• Intentionally failing to pay taxes

With these common indicators, you become a prime suspect for tax fraud.

So what are the penalties for criminal tax fraud and civil tax fraud?

Civil tax fraud penalties do not result in criminal prosecution— they are limited to monetary consequences. Common penalties include;

• Fraudulent failure to file a tax return: 15% of the underpaid tax due for each month up to five months. The penalty, however, won’t exceed 75% of the unpaid tax.
• Filing a fraudulent tax return: 75% of the underpayment amount.

If you are charged with criminal tax fraud, the potential penalty will be calculated based on the specific criminal charge you face. The penalties include a significant amount of imprisonment.

Here are common crimes and punishments linked to criminal tax fraud;

• Tax evasion: This is a willful attempt to defeat or evade tax. The crime attracts a maximum sentence of five years imprisonment and a $100,000 fine (for individuals) and $500,000 (for corporations).
•  Failure to file, failure to keep sufficient records, or willful failure to pay tax: you could serve a maximum term of one year imprisonment for this crime. The penalty also includes a $25,000 fine for individuals and $100,000 for corporations.

It’s worth noting that you could face both criminal and civil penalties for the same actions.

Can you abate IRS tax penalties?

If you’ve been charged with various tax penalties, you may request relief from the IRS. However, the IRS may only grant penalty abatement under the following conditions:

• You have a reasonable cause
• A statutory exception
• First-time abatement (FTA) waiver—only applicable for a single tax period

You can only use the FTA if you have had no penalties in the past three years and are in full tax compliance.

Reasonable cause abatement, on the other hand, is only applicable in situations that involve illnesses, natural disasters, and other events that are out of your control and cause you to miss a payment or file a deadline.

Moreover, if you receive erroneous advice from the IRS that causes a tax penalty, you may be eligible for penalty abatement due to statutory exceptions.

Need Help?

As a responsible taxpayer, you should always file your returns in time to avoid potential penalties. But sometimes mistakes happen, knowingly or unknowingly, which leads to IRS tax penalties and interest. If you’ve been charged by the IRS for failing to meet your responsibilities as a taxpayer or going against the tax laws, we can help. Contact us today for a free consultation.