Understanding Tax Penalties and Fines

Mistakes happen; sometimes, you miss a tax payment or forget to file your taxes on time. Understanding IRS tax penalties and fines is essential to avoiding penalties altogether or limiting the amount you owe to the IRS.

This article covers the basics of how IRS penalties work and provides tips on avoiding them or limiting what you owe.

What Does the IRS Charge Penalties For?

The IRS expects you to meet your tax obligations year after year without fail. If you fail to meet your tax obligations, you will most likely pay a penalty.

Some of the reasons that the IRS may charge a penalty includes failing to:

  • File your return by the deadline
  • Prepare an accurate return
  • Pay any taxes that you owe on time and in the correct way

While there are several penalties the IRS may assess, almost all of them are charged because of one of the three reasons above.

How Do You Know if You Owe the IRS a Penalty?

The IRS will notify you that you owe a penalty via an IRS notice or letter that is sent in the mail. The letter will describe why you are receiving the penalty, how much you owe, and what the next steps are.

If you miss the initial notice, don’t worry! The IRS will send a follow-up notice letting you know that they haven’t heard from you and that you now owe more money than before.

The IRS has a different notice or letter for practically everything. To learn about the different types of notices, read our article entitled, “What Does the IRS Send Notices For?“

How Do IRS Penalties Work?

Each type of IRS penalty works a little differently. However, there are two basic components to each penalty:

  • Penalty – the amount owed for failing to meet your tax obligation on time.
  • Interest – the increase of the penalty amount and any owed taxes over the period you fail to pay your penalty and owed taxes.

The interest charged on your taxes typically occurs for each month that you fail to pay your taxes and penalties. Therefore, it’s best to pay any owed taxes before the start of the next month to avoid additional interest. However, the good news is that most IRS penalties typically have a cap on the amount that can be charged.

Common Types of Tax Penalties

The IRS has a long list of penalties that they send notices and letters for. However, there are a few penalties that are assessed more often than others.

Failure to File

The failure to file a penalty occurs when you fail to either file an extension or file your taxes by the tax deadline. The penalty is 5% of your unpaid taxes for each month that your return is late, with a maximum cap of 25% of the taxes owed. This penalty is not applied if the IRS actually owes you a tax refund, but you may lose your refund if you fail to file within three years of the original due date.

Failure to Pay

The failure-to-pay penalty happens when you fail to pay taxes owed to the IRS on time. The penalty is 0.5% of the taxes owed per month, with a cap of 25% of the total taxes owed. Filing a tax extension will help you avoid a failure-to-file penalty, but not a failure-to-pay penalty.

Underpayment of Estimated Taxes

If you are self-employed or don’t have taxes taken out of your paycheck, you need to pay the IRS estimated quarterly payments. At the end of the year, if you owe more than $1,000, you could be charged a penalty.

The penalty is assessed based on the difference between the amount of estimated taxes you paid in each quarter and the effective interest rate for that quarter. The rate and amount that you may owe as a penalty can vary from quarter to quarter.

The IRS does offer two “safe harbor” options if you do end up miscalculating your estimated taxes. If you pay 90% of the taxes you owe in the current year or 100% of the previous year’s owed taxes (and make estimated payments), then you can potentially avoid the penalty.

Dishonored Check

If you write a check or set up an automatic withdrawal and don’t have the money in your account to cover the amount, the IRS will assess you a penalty.

The penalty for a dishonored check is 2% of the check’s value. However, if the check is less than $1,250, the penalty is $25, or the amount of the check if it’s lower than $25.

How to Avoid IRS Penalties

The best way to avoid IRS penalties is by filing and paying your taxes on time. However, mistakes do happen, and the IRS recognizes this. In instances where you have reasonable cause for missing a penalty or payment, or it’s your first offense, the IRS may waive the penalty.

Getting penalty abatement from the IRS isn’t always easy. Therefore, it’s best to use IRS Shield to help walk you through working with the IRS. We can help you communicate your situation to the IRS to give you the best shot at being approved for penalty abatement.

If this isn’t your first time getting a penalty or you’ve accrued a large amount of tax debt, check out our article on how to resolve your debt with the IRS.

How to Resolve Your Debt with the IRS

Falling into debt with the IRS is never a good idea. However, surprises happen, and unexpected taxes pop up. The good news is if you owe a large amount of money to the IRS, you may not have to pay it all!

You can resolve your debt with the IRS in 3 simple steps:

  1. File your taxes
  2. Ask an expert
  3. Consider your options

In this article, we look at each step in detail to help you move forward with resolving your IRS tax debt.

Step 1: File Your Taxes

It is absolutely essential to file your taxes each year! You should file your taxes even if you can’t afford to pay them.

While you do have to pay penalties on unpaid taxes, you’ll pay additional fees if you don’t file your taxes. The failure-to-file-penalty is 5% of the taxes owed per month, up to a maximum amount of 25%. Failing to file can significantly increase your tax debt.

If you’re not ready to file your taxes by the mid-April due date each year, you can file a tax extension to get an additional 6 months to file.

Step 2: Ask an Expert

If you owe a debt to the IRS, you should consult an expert before paying any debt. Depending on your financial situation, there are plenty of options that could help you avoid paying the full amount of debt.

While tax accountants can be very expensive, IRS Shield provides an alternative solution at an affordable price. For a low monthly fee, you can have access to tax professionals throughout the entire year. They can help walk you through your options and potentially save you money owed in back taxes!

If you currently owe a debt to the IRS and want help, you can contact our team here.

Step 3: Consider Your Options

When paying down tax debt, you have plenty of options to help you get out of debt quickly and pay less than the full debt amount. It’s vital to consider all of the options available to you and choose the option that makes the most sense for you.

Installment Plans

Installment plans are a good way to pay down an unexpected tax bill at the end of the year but don’t have the cash on hand to pay the full amount owed. Installment plans allow you to pay the debt in monthly payments set by the IRS.

In order to qualify for an installment plan:

  • Your IRS debt must be less than $50,000
  • You must be up-to-date with filing your tax returns

While installment payments are a great way to break a large debt into manageable payments, you still have to pay interest on the debt. Therefore, it’s better to pay the full amount of your IRS debt upfront if you are able to.

Offer in Compromise

The IRS wants to collect as much of the owed debt as quickly as possible. That’s why if you truly can’t afford to pay your tax debt, even in installments, the IRS may consider agreeing to an offer in compromise.

In order to qualify for an offer in compromise, you have to submit an application to the IRS that essentially details your entire financial situation. The IRS will look at your outstanding debts, income, and investments to see if you truly can’t afford to pay down the debt.

If you are approved for an offer in compromise, then the IRS will reduce the amount of debt you owe based on your financial situation. The full newly agreed-upon balance will be due within two years of finalizing the agreement.

Statute of Limitations

The IRS has 10 years from the date that you filed your taxes to collect any debt, penalties, or interest. While waiting 10 years to resolve tax debt may seem like an easy way out, the IRS will take serious action to collect any owed debt. They can garnish your wages, seize your property, and much more.

Currently Not Collectible Status

Instead of trying to hide from the IRS for 10 years, if you truly cannot pay any amount of the tax debt you owe, you can apply for currently not collectible status. While you still will eventually need to pay your taxes, it puts a hold on tax levies, wage garnishment, and most other actions the IRS can use to collect the debt.

Filing for Bankruptcy

A last resort option to resolve your IRS debt is to file for bankruptcy. Filing for bankruptcy can eliminate any debt you owe, but it comes with serious consequences. It may make it difficult to borrow money ever again, and it certainly will damage your credit rating for an extended period of time.

Choose the Option That’s Best for You

Before picking an option to resolve your tax debt, it is essential to consult a tax professional. We’ve only briefly touched on the options to resolve your IRS debt and each option comes with its own benefits and disadvantages. You need to ensure that you understand the consequences and benefits of each option before attempting to work with the IRS.