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Tax Penalties: Quick Reference Guide

Most Americans would rather not pay taxes on their income. But, the federal income tax is the primary way the U.S. government gains the money it needs to operate. That's why Congress added penalties to the tax code as an incentive for Americans to file and pay their income tax bills each year.

But, despite most taxpayers knowing that failure to file or pay can lead to the Internal Revenue Service assessing significant financial penalties, few understand what those penalties are.

The following sections will explain the most common IRS penalties, why the IRS applies them, and how the amounts get calculated. It will also explain some of the more drastic penalties included in the tax code to keep taxpayers from cheating on their taxes. Remember that the penalties get charged on top of any additional tax you must pay the IRS from underpaying your taxes or that you must repay after claiming a too-large refund. You must also pay interest on any taxes owed and unpaid penalties.

Common IRS Penalties

The federal tax code includes more than 150 penalties the IRS can assess against taxpayers. But many of those address specific tax situations that only apply to a small percentage of filers. The most commonly imposed tax penalties include:

  • Failure-to-file penaltyIt applies when you are legally required to file a tax return but don't do so by the due date. The late filing penalty is usually 5% of your unpaid taxes for each month a return doesn't get filed after the original due date, up to 25%. There is also a minimum penalty amount that gets adjusted annually for inflation.
  • Failure-to-pay penaltyThis gets assessed when you don't pay the tax by the due date, usually April 15, for the previous year's federal income tax returns. The penalty is usually 0.5% of your unpaid taxes, up to 25%.
  • Negligence or disregard of the rules and regulations penalty: It's an accuracy-related penalty when you don't reasonably attempt to follow tax laws when preparing your return. The penalty is 20% of the tax underpayment resulting from your negligence or disregard.
  • Substantial underpayment of income tax penaltyThis is another accuracy-related penalty. It applies if you understate your tax liability by more than 10% of the tax you should have reported on your return, or $5,000, whichever is larger. The penalty is 20% of the tax you should have reported on your return.
  • Erroneous claim for refund or credit penalty: This is when you claim an excessive tax refund or tax credit without having reasonable cause. The penalty is 20% of the refund or credit amount you claimed more than the amount owed to you.
  • Dishonored check or other forms of payment penalty: It gets applied when you don't have enough money to cover your payment to the IRS. The bank will dishonor the payment, and the IRS will declare the amount unpaid.
  • Underpayment of estimated tax by an individualThis gets assessed when you don't make large enough estimated tax payments throughout the tax year. This penalty is unusual because it is still assessed when a taxpayer gets a refund. This penalty gets calculated based on the underpayment amount, the time the tax was unpaid, and the published interest rates for penalties.

Major Tax Penalties

The IRS can assess two of the most drastic tax penalties for tax evasion and tax fraud. But, the IRS doesn't impose these penalties for minor mistakes or oversights on your return. To impose tax fraud and tax evasion penalties, the IRS must show that you acted intentionally.

Tax fraud penalties apply when you try to avoid paying the full amount of tax you owe, such as failing to report income or inflating tax deductions. In almost all cases, the IRS must find that you avoided significant tax amounts, usually more than $70,000. The civil penalty for tax fraud is as much as 75% of the tax due, but you will rarely face jail time. If the IRS chooses to bring criminal charges, you may face three years in prison and a $250,000 fine.

Tax evasion is a criminal act classified as a felony that can get you up to five years in prison and a $250,000 fine.

How Will the IRS Notify You?

The IRS can't assess penalties without telling you about them first. Usually, the IRS sends a letter to your last known address. While the IRS will send documents identified as letters or notices, they are generally called "notices." The notice will include information explaining which penalties it assessed, why they are being assessed, and what the taxpayer should do next.

If you get a notice from the IRS, it's always important to read it and not assume you know what it will say or that it is an error. The notice will also contain information on contacting the IRS about any penalty issues and the next steps you must take.

State Tax Penalties

Every state has its own system for applying tax penalties to those who underpay their tax liability. Remember, just because you live in a state without an individual income tax doesn't mean that the state department of revenue can penalize you for not paying other types of taxes, such as sales taxes, use taxes, and taxes on motor vehicles. Even if you live out of state, you may face state tax penalties in a state where you have business activities.

Still Have Questions? Talk to a Lawyer

Taxes can cause a large amount of stress, especially if you think you may face tax penalties. It doesn't help that the penalty provisions in the tax code is difficult to understand if you are not a tax preparation professional. You can contact an experienced local tax attorney to discuss how to manage your tax issues best. A tax attorney can give you additional information and negotiate a payment plan to help you avoid collections.

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Contact a qualified tax attorney to help you navigate your federal and/or state tax issues.

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