The Definitive Guide to IRS Penalties

Reasons the IRS can charge you a penalty.

Last year, the IRS collected more than $3.4 trillion from taxpayers. Part of that total consisted of more than $11 billion in penalties on individual, trust, and estate income tax returns. [Source]

The $11 billion didn’t include penalties on early distributions to IRAs. In fact, there are multiple reasons the IRS penalizes taxpayers. Let’s take a look.

Common reasons for IRS penalties

The most common IRS penalties include:

ReasonPenalty
Failure to file5% a month for up to 5 months
Failure to pay taxes on time5% – 25%
Failure to pay correct estimated tax# days x current interest rate (~9%)
Bad check2%
Early distribution of IRARegular tax + 10% penalty

The IRS has a long list of reasons to penalize taxpayers for mistakes or omissions.

Anthony E. Parent, Esq. is co-founder and managing partner of Parent & Parent LLP, a tax preparation and consultation service.

“Countless IRS penalties exist, but the the bulk come from not making tax payments on time,” he says.

Some common reasons for IRS penalties include:

Failure to file

This refers to not filing your tax return when it’s due in mid-April. It can also mean not filing by the extended due date, if you filed an extension.

  • Penalty: 5% of the unpaid tax. The IRS charges this penalty for up to five months.

Failure to pay taxes due

If you don’t pay the taxes reported on your return by the due date, you’ll have to pay penalties. Taxes are due in mid-April, even when you file an extension.

  • Penalty: 5% of taxes not paid by due date for each month or part of a month that the tax is overdue. The penalty won’t exceed 25% of the unpaid tax due. If the taxpayer doesn’t have sufficient funds to pay all of the tax, but an installment agreement is put in place, an additional 0.25% is also due.

Failure to pay correct estimated tax

If you’re self-employed and expect to owe at least $1,000 in taxes, it’s necessary to pay estimated taxes. Failure to pay quarterly estimated tax payments will result in a penalty.

  • Penalty: The IRS calculates penalties for missed estimated tax payments. The IRS bases the penalties on the number of days late and multiplies by the current interest rate.

Bad check

If your bank doesn’t honor your check or another form of payment to the IRS, you will owe penalties.

  • Penalty: For checks of $1,250 or more, the penalty is 2% of the check amount. For payments less than $1250, the penalty is the lesser of the 2% amount or $25.

Early distribution on an IRA

Often, you will pay a penalty if you withdraw from an IRA (Individual retirement account) before age 59 ½.

  • Penalty: The IRA amount you withdrew is added to your gross income and taxed. There will also be an additional 10% penalty.

Penalty relief options

Many taxpayers don’t realize that there are penalty relief options that can save you money. Here are a few to consider.

Penalty Abatement

Parent says, “Taxpayers can call the IRS to get abatement of at least one year of penalties.” With Penalty Abatement, you may get penalties waived as well as interest reduced or removed.

You’re eligible if you’ve had no penalties for the prior three tax years. You must also have filed all returns or an extension and paid or arranged to pay taxes due.

In 2017, the IRS abated $12,574,391 in civil penalties. If you qualify for abatement, it’s worth a try. [Source]

Reasonable Cause

You may also get penalty relief for a reasonable cause—for instance, if circumstances in your life made it impossible to meet your tax obligations.

You’ll have to prove your case by providing information and supporting documentation. [Source]

Reasonable causes include:
  • Death
  • Serious illness
  • Incapacity or unavoidable absence of taxpayer or his or her immediate family
  • Fire, natural disaster, or casualty experienced by taxpayer
  • Inability of taxpayer to obtain necessary records

Offer in Compromise

Another tax relief option is an Offer in Compromise (OIC). Such an agreement negotiates tax liabilities for less than the full amount owed.

An OIC isn’t easy to get. The IRS will accept an OIC for only three reasons:

  1. You can’t afford the full amount. You may be eligible for an OIC if you don’t have the income or assets to afford the full tax debt owed before the 10-year statute of limitation ends.
  2. Economic hardship. You’ll have to prove that paying the full amount would cause you economic hardship.
  3. Doubt regarding the amount you owe. You may qualify for an OIC if there are doubts over the amount of tax debt you owe or whether you really owe it.

How to avoid IRS tax penalties

Of course, it’s best to avoid IRS tax penalties altogether.

Parent says, “The number one way to avoid penalties is to make sure you pay on time. Most penalties are a result of a tax balance due.”

Penalties tend to occur the most with self-employed individuals and those who file extensions.

“Self-employed taxpayers make the mistake of underestimating what they owe because they don’t factor in the approximately 16% in tax liability for self-employment taxes,” says Parent.

People also think that filing an extension means they have extra time to pay. You must pay with your extension when you submit IRS Form 4868. Otherwise, you’ll pay penalties, interest, and late fees. Extensions are six months.

According to Parent, the key is to pay as you go. “The IRS imposes most penalties when there is a balance due,” he says.

“For example, if you haven’t filed taxes in the past three years, yet you had wages withheld, you generally won’t get penalized. If you file late and are entitled to a refund, there will be no late filing penalties.”

Take IRS penalties seriously

The IRS can be aggressive in assessing and collecting tax penalties. “In 1955, there were 14 tax penalties provisions,” says Parent. “Now there are more than 140.”

Parent urges people to remember that the IRS is adversarial in nature. “While individual agents may be decent people, the system is brutal,” he says.

“The IRS penalty regime deserves tar and feathers. Always remember that IRS employees represent the government, not you.”

When to get a loan to pay the IRS

If you end up owing Uncle Sam a significant amount of money, it may make sense to borrow the funds to pay.

Before you apply for a loan, make sure you’re caught up on filing and paying the current year’s taxes.

Parent advises, “It makes no sense to pay off yesterday’s tax bill and penalties, just to get hit with underpayment penalties for this year. Millions of Americans on the IRS penalty treadmill have paid billions over the years that they wouldn’t have if they’d had a better strategy.”

Tax relief and IRS penalties

But if you can get a tax relief loan for lower than 10% APR, then it might make sense. The IRS determines interest rates every quarter. For taxpayers other than corporations, the rate is the federal short-term rate, plus 3 percentage points. The federal short-term rate is 6%, which puts the IRS rate at 9% (source).

If you owe less than $50,000, you can pay via IRS Simplified Payment Plans that reduce accrued penalties. Some of the plans involve fees in addition to interest, so it pays to compare.

Other options include borrowing from a 401(k), family member, or home equity line of credit. “Usually, those interest rates will beat the IRS,” says Parent.

Consider working with a top tax relief firm to ensure you’re heading down the right path.