The Most Common Tax Penalties and How to Avoid Them
A financial penalty from the Internal Revenue Service (IRS) feels like money down the drain. When you incur tax penalties in the United States, not only do you still owe taxes to the IRS, but you will need to pay the resulting fees, as well. Many taxpayers incur penalties without realizing their errors, forcing them to pay more than just their tax bills. So, what are the most common tax penalties and how do you stay clear of them?
The first step is to understand where the risks for tax penalties lie. Once you know, you can make informed decisions on which actions to take and how to best reduce your overall tax burden. Here are some of the most common tax penalties, with ideas on how to avoid them:
Failure to File
For most Americans, filing taxes is an annual chore they’d rather skip. But in the eyes of the IRS, it is a must. Even if you don’t think you’ll owe taxes, it is important to file your return.
In 2024, Tax Day in the United States—the day that individual tax returns are due—is April 30th. This means that you have until this day to file your taxes for the 2023 tax year. If you need more time, you can request an extension, but if you miss either your tax deadline or your extended deadline, the IRS will charge a Failure to File penalty.
What does this tax penalty look like?
One of the most common tax penalties, the Failure to File penalty amounts to 5% of the unpaid tax for each month—or even part of a month— that your return is overdue. This penalty caps out at 25%, or five months, of your balance.
If you are more than 60 days late with your return, you will incur a minimum penalty of $450, or 100% of the tax owed, whichever is less.
If you will be receiving a refund from the IRS, the consequences of failing to file are different. While you won’t likely be charged a Failure to File penalty, you will miss out on the use of your refund money. If you leave it for three years from the original due date, you could lose your refund altogether.
Of course, if you don’t file your taxes and assume you are owed a return, you run the risk of being wrong. If you’ve made errors in your calculations and eventually find that you owe the IRS money, you will also incur one of the most common tax penalties.
To avoid this penalty, make sure you file your taxes by the IRS deadline each year. Whether or not you expect a refund, it is important to meet the IRS deadline. If you disagree with the amount the IRS says you owe, consider working with a tax professional to help you navigate your situation.
Failure to Pay
Assuming you owe tax money to the IRS, you are obligated to pay the amount when you file your taxes, either at your original or extended deadline. Failure to Pay is one of the most common tax penalties because it goes hand in hand with the Failure to File penalty. If you don’t pay your taxes, it is highly unlikely that you’ve filed them.
If you owe more than you can afford to pay at tax time, the IRS suggests that you pay as much as you can by the annual tax deadline and that, if you cannot pay the balance within a few months, you should think about requesting an installment agreement.
What does this tax penalty look like?
Much like the Failure to File penalty, the Failure to Pay penalty is charged in full each month, even when you only owe taxes for part of the month. The penalty is 0.5% of your unpaid taxes per month, or partial month, to a maximum of 25% of the taxes due.
If you engage in an installment agreement with the IRS, where you pay your taxes on an agreed-upon schedule, your Failure to Pay penalty will be reduced to .25% of your taxes owing, for the duration of the agreement.
Of course, this tax penalty is incurred for several reasons. You may not have the money available to pay your taxes by the due date, you may not understand the option to engage in an installment agreement or you may disagree with the amount the IRS says you owe.
No matter the reason you incur this common tax penalty, it’s important to understand what it means. To avoid this penalty, find a tax expert you trust to help you negotiate an installment agreement or dispute the amount owing.
According to the IRS, the two most common tax penalties related to tax returns are Substantial Understatement and Negligence or Disregard of the Rules or Regulations.
As an individual, you can incur a Substantial Understatement penalty if you understate your taxes owed by 10% or $5,000, whichever is larger. You can only avoid this penalty if you have adequately disclosed the reason for this understatement, with documented proof.
The Negligence or Disregard of the Rules and Regulations penalty can be used for a broad range of reasons. For example, the IRS may decide that you have failed to make a reasonable attempt to comply with tax laws, keep adequate books and records, use reasonable care in preparing your tax return or made other infractions. This penalty is almost exclusively incurred by taxpayers who file their own taxes and fail to follow the basic requirements.
What do these tax penalties look like?
These two tax penalties are charged at a flat 20% rate of the net understatement of tax. In other words, the IRS is ready to use a hefty fine to discourage underestimating income. The more you underestimate, the greater your penalty.
To avoid the two most common tax penalties related to accuracy, take your time in filing your taxes, resist the temptation to understate your income and consider working with a team of professionals. Tax experts have deep experience that will help you avoid unnecessary penalties while making sure you take advantage of tax credits available to you.
Other Tax Penalties
While the penalties listed above are the most common tax penalties faced by U.S. taxpayers, there are many more that you’ll want to avoid. If you submit a frivolous tax return, for example—one that fails to include enough information to determine the amount of tax owed—you could be slapped with a fine of $5,000. Similarly, if you bounce a check you’ve written to the IRS, the agency may impose a penalty of up to 2% of the amount of the check.
Naturally, more serious penalties can be incurred where the IRS suspects fraud. Whether you are unsure of the accuracy of your tax reporting or disagree with the amount the IRS says you owe, your best bet to avoid paying tax penalties is to hire an experienced team of tax professionals.
At Franskoviak Tax Solutions, we have helped thousands of clients with taxes and tax problems for more than 30 years. We provide comprehensive tax services with first-class expertise and a personalized, boutique-style approach. Speak to our team about personal and business taxes, IRS tax deadlines, payroll taxes, IRS tax relief and tax problems such as IRS tax notifications, payroll tax debt, delinquent taxes and more.
Start with a free consultation—we’re here to help you file your taxes easily, without incurring unnecessary tax penalties.