Most savvy entrepreneurs and business owners – if not all – do not enjoy parting with their hard-earned money during tax season. But guess what could make paying taxes even more exasperating? Unexpected tax penalties due to compliance missteps. With tax deadlines looming, there is no better time for you to navigate the murky waters of tax penalties.
The IRS outlines 11 distinct types of tax penalties, and we’re here to give you a concise, clear rundown of each, ensuring you’re not just tax-compliant but also penalty-proof. Because in the world of taxes, knowledge isn’t just power—it’s your hard-earned money saved from the jaws of the taxman. Buckle up; it’s going to be an enlightening ride.
Below are some of the most common types of tax penalties you need to steer clear of this tax season.
- Failure to Pay: The IRS imposes a penalty if you don’t pay your reported taxes by the due date or even by an extended deadline. Think of it as a late fee. For every month you delay payment, you’ll be charged an additional 0.5% of the unpaid tax. However, the total penalty won’t exceed 25% of the taxes you owe. It’s the IRS’s way of urging timely tax payments.
- Information Return: If you fail to file information returns or issue payee statements on time, you could face a financial penalty from the IRS. Should this happen, you’ll receive a Notice 972CG in your mailbox. Additionally, interest will accrue monthly on the unpaid balance until it’s fully settled. Unlike some penalties, there’s no set cap on how much you could owe. The penalty rate varies based on factors like your business size and whether the oversight was intentional.
- Underpayment of Estimated Tax by Individuals: If you’re an individual, estate, or trust and you’ve underpaid your estimated taxes, beware: the IRS can hit you with a penalty. Interestingly, you might still be on the hook for this penalty even if the IRS owes you a refund. The penalty isn’t arbitrary; it’s calculated based on three key elements: the amount you’ve underpaid, the period during which the underpayment occurred, and the current interest rate for underpayments, which the IRS updates every quarter. Keep these factors in mind to avoid unwanted surprises come tax time.
- Underpayment of Estimated Tax by Corporations: The IRS imposes a specific penalty on corporations that either fail to pay their estimated tax on time or underpay the amount due. Much like the penalty for individual taxpayers who underpay their estimated tax, a corporation can be hit with this fine even if it’s otherwise eligible for a tax refund. The calculation for this corporate penalty closely mirrors the one used for individual taxpayers and is based on the same three key factors.
- Failure to File: If you miss the deadline for filing your tax returns, including any extensions, you risk incurring a “Failure to File” penalty from the IRS unless you have a valid reason for the delay. The penalty accrues monthly and is calculated at 5% of your outstanding tax balance. Also, the maximum payable rate for this penalty is 25% of your unpaid taxes.
- Erroneous Claim for Refund or Credit Penalty: This is the penalty the IRS requires you to pay for submitting a claim for an excessive amount of refund or income tax credit. An ‘excessive amount’ is defined as the additional amount on the allowable tax credit or refund for the taxable year. The IRS charges a penalty fee that is 20% of the excessive amount claimed.
- Accuracy-Related Penalty: This penalty is a result of paying less than the tax amount that you are required by law to show on your tax return. Typically, an underpayment involves defaulting on reporting all your taxable income or claiming refunds that you are not entitled to. There are two types of Accuracy-related penalties that the IRS commonly imposes on offenders. They are:
- Negligence or Disregard of the Rules or Regulations: ‘Negligence’ here is defined as making no reasonable effort to adhere to tax laws in the process of filing your returns while ‘disregard’ is an act of intentionally or recklessly choosing to ignore tax regulations.
- Substantial Understatement of Income Tax: A tax return error that involves understating your tax obligation by 10% or $5,000 will attract a Substantial Understatement of Income Tax penalty from the IRS.
8. Failure to Deposit: This is a tax penalty that the IRS imposes when an employer fails to pay employment tax deposits accurately or on time. The IRS requires employers to pay employment tax deposits every month, and the list of employer-paid taxes includes Federal Unemployment Tax, Federal Income Tax, Social Security Taxes, and Medicare Taxes. A defaulting employer will be required to pay a penalty amount that is a percentage of the exact tax amount they did not pay on time or accurately. The exact penalty rate is determined by the number of days that the tax deposit is late. It is 2% for 1-5 days late, 5% for 6-15 days late, 10% for more than 15 days, and 15% for a 10-day lateness after receiving the first notice.
9. Tax Preparer Penalties: As the term implies, these are penalties that apply to any individual who receives payment and is legally allowed to prepare taxes for engaging in tax malpractices. The IRS considers factors such as the number of involved tax years, the number of tax violations, the type of regulations violated, and the rates of inflation when calculating tax preparer penalties.
10. Dishonored Checks or Other Form of Payment Penalty: This is a penalty that applies to any individual who tries to settle their tax payment from an insufficient bank balance. Such an attempt leads the individual’s bank to dishonor the payment, send back the bad check, and declare the due tax amount unpaid. The exact penalty amount is contingent on the amount of the failed payment attempt (bad check or e-payment).
11. International Information Reporting Penalty: Engaging in certain international financial activities requires you to adhere to the corresponding tax laws or regulations. Failure to do this attracts the International Information Reporting penalty, which the IRS calculates based on various factors related to your tax returns. You may be able to avoid paying this tax penalty even after receiving a notice from the IRS if you manage to correct the specified promptly.
Can You Legally Avoid Paying a Tax Penalty?
YES! You can avoid giving even a cent of your hard-earned money away to tax penalties. The best and easiest way to ensure this is to always adhere to tax regulations and settle tax obligations on time.
Technically, staying on the right side of tax regulations at all times is no easy feat, as the world of taxes can be overwhelming and confusing, considering the growing and evolving nature of the U.S. tax code. But here is the good news: You can opt out of the technicalities of the tax filing or preparation process and still maintain 100% compliance. Did you ask how? The answer is Tax Goddess.
Your Path to a Penalty-free Future
At Tax Goddess, we focus on helping savvy entrepreneurs, business owners, and employees like yourself navigate the complex world of taxes. We are specialists in preparing taxes, identifying loopholes in the tax code, and implementing above-board tax strategies to help you claim substantial tax savings while ensuring compliance.
So, if you are serious about putting a stop to paying excessive taxes or being a victim of unwanted tax penalties, book a free consultation with us today, and let’s help you flip the script on the IRS. You deserve better than paying avoidable tax penalties that contribute nothing to improving your life.