IRS Penalties Overview

Taxpayers are responsible for getting their own tax returns right, or they may face penalties from the IRS. Here’s an overview of the most common types of penalties, when they apply, and how much they could cost you.

Types of IRS Penalties

Late Filing/Failing to File

If you fail to file your tax return by the deadline, a penalty of 5% of the unpaid tax applies for each month or part of a month until you pay.

The maximum penalty for failing to file is 25%. After five months, failing to pay penalties and interest still applies, but the failing to file penalty is capped.

If you file more than 60 days late, the minimum failure to file penalty is the smaller of $205 or 100% of your unpaid taxes.

The penalty does not apply to any portion of the tax due that you paid through withholdings, estimated taxes, or other deposits.

This penalty may also apply when the IRS adjusts your balance due and you fail to pay by the due date on the notice.

Example: A W-2 wage earner who had $20,000 in taxes due and only $10,000 in withholding and filed…

• One month late: $500 failing to file penalty ($10,000 owed x 5%).
• Two months late: Additional $500 for $1,000 total.
• Three months late: Additional $500 for $1,500 total.
• Four months late: Additional $500 for $2,000 total.
• Five months late: Additional $500 for $2,500 total (the taxpayer is now at the 25% cap).
• Six+ months late: No additional failing to file penalty. Interest and failing to pay penalties still apply.

Always file your tax return on time (or file for an extension) even if you can’t pay because the failing to file penalty is substantially larger than the failing to pay penalty.

Failing to Pay on Time

If you fail to pay your taxes when due, the IRS adds an underpayment penalty of 0.5% of your unpaid tax debt for each month or part of a month that the balance remains unpaid. The total failing to pay on time penalty cannot exceed 25%.

Exceptions:

• If you’re also assessed failing to file penalties in a month, the maximum combined penalty is 5% (0.5% failing to pay + 4.5% failing to file).
• When you’re making automatic payments on an installment agreement, the failing to pay penalty is reduced to 0.25% per month.
• If the IRS issues a final notice of intent to levy or seize property, the failing to pay penalty increases to 1% per month beginning 10 days after the date of the notice.

Example: Continuing the example from failing to file…

• Months 1-5: The penalty is capped at 5% combined, so the total penalty remains $500.
• Months 6+ (or sooner if the taxpayer files sooner): The failing to pay penalty is 0.5% x $10,000 owed = $50 per month.
• If the taxpayer goes on an installment agreement, the penalty is reduced to $25 per month* (0.25% failing to pay x $10,000).
• If the IRS issues a notice of intent to levy, the penalty is increased to $100 per month* (1% of $10,000).

* As you pay your balance down, the penalty decreases because it’s based on what you currently owe not the original balance.

The maximum total combined penalty for failing to file and failing to is 47.5% rather than 50%. This is because the 5% monthly cap on combined penalties effectively waives 0.5% of the late filing penalty in the first 5 months or 2.5% total.

In some situations, you may be able to have penalties reduced or removed by applying for IRS penalty relief.

Accuracy-Related Penalty

In addition to the failing to pay penalties, an accuracy-related penalty may also be assessed in certain situations. These include:

• Negligence.
• Disregard of tax rules and regulations.
• Substantial underpayment.

The penalty is 20% of the additional tax owed.

Negligence

Negligence means failing to make a reasonable attempt to properly complete your tax return. It also includes failing to make a reasonable attempt to keep adequate books and records to complete your return or to back up your return.

This is a gray area but it does not include all errors. It depends on whether there was reasonable cause for the error, the complexity of the issue, and your level of knowledge.

Disregard

Disregard means that you ignored provisions of the tax code when completing your return. This includes both acts that are similar to negligence and intentional oversights in an effort to avoid paying taxes.

Substantial Understatement

An understatement is substantial if it exceeds the greater of:

• 10% of the total tax required to be shown on the tax return in question.
• $5,000.

Interest

Interest is charged in addition to any penalties at a rate of the short-term federal funds rate plus 3%. There is no cap on interest.

Failing to Pay Estimated Taxes

The estimated tax penalty applies to taxpayers who owe too much at the end of the year because they had inadequate withholding, estimated tax payments, or other deposits. You can calculate the penalty on Form 2210, and the current rate is about 4% of the shortfall.

Most taxpayers can avoid estimated tax penalties by making quarterly estimated tax payments of the smaller of 100% of their previous year’s total tax liability (not just what they owed when filing) or 90% of the current year’s.

Higher income taxpayers may need to pay 110% of the previous year or 100% of the current year.

Special rules apply to certain industries such as fishermen and farmers.

The estimated tax penalty is called a penalty but acts more like interest. If you file and pay by your tax return due date, your return and payment are on time.

However, failing to pay estimated taxes on time is a default on an installment agreement.

Failing to Deposit Withholding Taxes

The IRS penalties for failing to deposit payroll taxes you withheld from your employees’ paychecks are severe. The first penalty is a late penalty of:

• 2% if 1-5 days late.
• 5% if 6 to 15 days late.
• 10% if 16+ days late.

In addition, the business owners or other responsible parties are personally liable for 100% of any deposit shortfall. This applies even if the business is a corporation or other entity that would otherwise provide protection from personal liability for business debts.

Because payroll tax withholdings come out of your employees’ paychecks rather than from business assets, the IRS considers failing to make payroll tax deposits as essentially theft from your employees. The IRS may pursue additional civil penalties or criminal prosecution against any person who fails to make the required deposits.

Failing to Provide an Information Return (W-2, 1099, etc.)

If you do not provide a W-2 or 1099-MISC to your employees or independent contractors by January 31st, per return penalties apply.

• 1-30 days late: $50.
• 31 days late to August 1st: $100.
• After August 1st: $260.
• Intentional disregard: $530.

Example: You provided W-2s for 10 employees 15 days late. The penalty is $50 x 10 = $500.

Different deadlines and penalties apply to other types of information returns, but the overall concept is the same.

Failing to Report Foreign Assets and Income

U.S. citizens must report most foreign earned income. You also must report your ownership of many types of foreign assets such as bank accounts or foreign stocks. (This does not include international stock funds traded on a U.S. stock market.)

Penalties vary based on the type of income or asset as well as the purpose of the transaction. For example, a tax shelter versus a frequently traveler keeping spending cash at a foreign bank. In some cases, criminal prosecution may result.

Tax Evasion/Fraud

Tax evasion or other types of fraud potentially carry both civil and criminal consequences.

The civil penalty is up to 75% of the unpaid tax plus any other applicable penalties and interest. The criminal penalty is up to $100,000 ($500,000 for a corporation) plus five years in prison.

If you believe you are under investigation for tax evasion or tax fraud or believe you may have committed tax evasion or tax fraud, you must speak to a tax lawyer not a tax accountant.

While an accountant can handle most IRS disputes, an accountant cannot represent you in court. Additionally, the IRS may be able to force an accountant to reveal information that if given to an attorney would be subject to attorney-client privilege.

If you hire an attorney first, your attorney can hire an accountant for you and maintain attorney client privilege.

What to Do About IRS Penalties

The first step if you’re facing IRS penalties is to determine whether you agree with why the IRS changed your tax return.

If you agree the changes are correct, you’ll need to pay the adjusted balance but may be eligible for penalty relief. If you don’t agree, ask your tax professional how to respond to the IRS notice or begin the appeals process.

What does penalty abatement mean?

You may hear penalty relief and penalty abatement used interchangeably. Penalty abatement means to remove the penalties. In this context, they’re penalties that you actually owed rather than penalties that you challenged successfully. You can think of it like a judge giving you a lesser sentence or reducing your traffic ticket.

What IRS penalty relief options are available?

You may qualify for one or more of the following programs depending on your IRS payment history and the tax issue.

IRS First-Time Penalty Relief

The IRS first-time penalty relief program applies to failure-to-file, failure-to-pay, and failure-to-deposit penalties. It does not apply to any other type of penalty.

To qualify for first-time penalty abatement, you must meet three qualifications:

• All returns filed or under a valid extension.
• Must have paid or arranged to pay (e.g. an installment agreement) all tax due.
• No prior penalties within the preceding three years. Exceptions: Estimated tax penalty and penalties relieved for reasonable cause.

In most cases, you will get approval for your IRS tax penalty abatement request as long as you meet the qualifications. If you have already paid the penalties, you can request a refund.

IRS Penalty Relief Due to Reasonable Cause

IRS penalty relief may also be available in situations where penalties would normally apply but you had a good excuse. Common examples include the following.

• Flood, fire, or other disaster.
• Death or serious illness of a family member.
• Records lost or destroyed through disaster or theft.
• Incarceration.
• Civil disturbances.
• Incorrect information from the IRS.
• Incorrect advice from a tax professional.

Reasonable cause is not a black-and-white issue. You must also explain to the IRS why you were prevented from filing or paying. You also need to do what you can as soon as you can.

Example: You get stuck in a foreign country due to an airline strike right before your filing deadline. If you file within a week or two of when you’re able to return home, the IRS will likely find reasonable cause. IRS penalty relief would likely not apply if you waited for months to file or never filed at all.

Example 2: Your tax records are destroyed in a fire. The IRS will likely find reasonable cause if it takes you a little longer to file or if you no longer have full supporting documentation for every item on your return. The destruction of your tax records is not reasonable cause for not filing at all, because you can use bank records and other information to complete your tax return as best as you are able to.

Example 3: You were overly aggressive in your business deductions (such as trying to deduct a Rolex) due to bad advice from your tax professional and the IRS imposed a negligence penalty or substantial understatement penalty. If you explain to the IRS why you believed you could rely on the tax pro’s advice in good faith, how you discovered the problem, and how you’re fixing it going forward, you may qualify for reasonable cause penalty relief.

IRS Fresh Start Penalty Relief

If you’re struggling financially, you may be eligible for the IRS Fresh Start program. The purpose of this program is to help taxpayers get out of tax debt by providing easier access to existing IRS penalty relief options. You can think of this program as almost like a bankruptcy but only for your taxes.

You will generally qualify if you meet the following requirements:

• You must owe less than $50,000.
• You must earn less than $100,00 as a single filer or $200,000 as a joint filer.
• If you’re self-employed, you must prove a 25% drop in income.

The primary purpose of the Fresh Start program is to make it easier for taxpayers to get an offer in compromise. An offer in compromise lets you settle your tax debt for less than what you owe. You make a lump sum payment to cover your outstanding taxes due, penalties, and interest, and the IRS forgives the rest.

If you can’t qualify for an offer in compromise, you may be able to get a payment plan or take advantage of the other penalty relief options described above. If you don’t have any money to pay at all, you may be able to stop IRS collections by requesting currently not collectible status.

IRS Form 5500 EZ Penalty Relief Program

If you’re an independent contractor or own a small business, you may be required to file an annual report for your small business retirement plan. The penalties can be up to $150,000 per form at a rate of up to $250 per day late.

You may be eligible for the IRS Form 5500 EZ Penalty Relief Program if you have a one-participant plan covering a 100% owner or partnership. “One-participant” means you, your spouse, and no one else.

You can apply by filing your delinquent 5500 EZ form(s) and paying a fee of $500 per return. If you failed to file multiple returns for a single plan, the fee caps at $1,500 per plan.

How can you request IRS penalty relief?

If you get a notice from the IRS, don’t agree to penalties unless you’re sure they’re valid. Even if you can get relief and don’t actually pay the penalties, it will affect your eligibility for future first-time relief and may influence IRS decisions in future audits.

Most IRS penalty relief requests are done via letter. You may wish to have a tax professional draft this letter for you to ensure that it covers all of the criteria, has sufficient explanations, and contains any needed supporting documentation.

If you call the IRS, you can expect to wait a long time on hold, and they may not be able to help you by phone.

Does the IRS have a debt forgiveness program?

While the IRS may remove your penalties, it generally won’t forgive your tax debt. You’ll still need to pay any taxes you owe.

If you need more time to pay, you can request an IRS payment plan. If you’re unable to pay, you can pause collections or try to settle your tax debt.