Most taxpayers are well aware of the IRS’s power to assess penalties and interest for non-payment of taxes due. What most taxpayers don’t understand is all the potential penalties that may be imposed, nor do they know how these penalties may be abated.
The format of this blog doesn’t allow for a detailed discussion of each penalty. IRS Notice 746 does that over four pages in pretty small print. We can look at some general classes of penalty. We can also look at circumstances that may allow the penalties to be waived or at least reduced. Interest is statutory and can’t be waived, but penalties are not.
Deposit Penalties. These penalties largely affect employers. Employers withhold taxes and make matching contributions for Social Security and Medicare. These deposits are required to be sent to the Department of Treasury on a set schedule. If those deposits are not made on schedule, penalties may range from 2% to 15% of the amount due. The later the deposit, the higher the percentage charged.
Prevention is a three-part process. The deposit must be made timely, to the correct address and the manner prescribed by the code. With this particular penalty, anybody in the company who can sign checks and make payroll decisions may be held liable. Competent professional help is essential for all areas of payroll.
Underpayment Penalties – This class of penalties can be applied to all types of taxpayer entities from sole proprietorships to C – Corporations. In fact, corporations have even higher fines than sole proprietorships.
These penalties arise largely from organizations not properly estimating taxable income or assuming they could make it up at the end of the year. The problem with this line of thought is that it ignores the character of the tax system. The federal tax code specifies that our tax system is a pay as you go system. Under the current system, when the return is done after the end of the year, the difference is paid as a result of the accounting in the tax return, whether it is a refund or amount owed the government.
Failure to File, Incomplete Returns – These penalties arise when a return either isn’t filed or important information is missing. To be a valid return, the taxpayer must represent that it is a return, it must be signed, and it must be complete. Individual returns are only required to be filed when income is high enough to be taxable. Despite this, if there is any income, an individual should file a return.
Filing an individual return sets the start date for the statute of limitations. It also communicates the taxpayer’s position to the IRS and may prevent questions by the service.
Corporations and partnerships must file a return regardless of the gross income. This is largely because these entities must issue a Form K-1, to all members of the partnership and certain key persons in a corporation so they can file their individual returns.
I mentioned the possibility of having penalties abated, either partially or completely. The IRS will not offer this possibility. They will happily asses the taxes, penalties and interest. Assuming the taxes due amount is accurate (This is how penalties and interest are computed), the minimum due is the taxes and interest.
Penalties can be waived by the IRS if the taxpayer makes a compelling argument. The first offense is generally pretty easy to get a penalty waived. After the first offense, to get a penalty waived requires a compelling case and the IRS gets to decide if the case is compelling. Generally, the cases with the most success are prepared by a professional representative.
In come cases when the penalties are very high, the taxpayer’s best avenue is tax court which requires professional help. This doesn’t require an attorney, but competent representation and assistance is essential.