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Tax Penalties: Quick Reference Guide

One of the most dreaded times of the year for many Americans rolls around on April 15, 2009 with the deadline for filing income tax returns. The prospects for filing this year may be even more dim for many due to the current economic downturn and worsening financial and employment conditions.

This article provides a quick reference guide to the various potential consequences of not filing a return or paying income taxes due in a timely and accurate manner. In-depth information on each penalty follows below, or just click on the links to jump to more information.

Timely Filers Who Do Not Pay Total Due: one-half of 1% of the tax owed for each month until tax is paid (25% maximum)

Late Filers: 5 percent of the tax owed for each month late (up to 25%); increased penalties for fraud

Combined Penalties: if both of the above apply): the failure-to-file penalty minus the failure-to-pay penalty

Frivolous Tax Submissions: $5,000 penalty

Mistakes: 20% of the underpayment

Civil Fraud: 75% of the underpayment

Criminal Penalties: civil fraud penalty (75%), plus substantial fines and jail time

Interest: for all late or under-paying filers, interest will compound daily on their unpaid taxes at the federal short term rate plus 3%

Timely Filers Who Do Not Pay the Full Amount Due

If someone files on time but doesn't pay the full amount they owe on time, they will usually have to pay a late payment penalty of one-half of one percent of the tax owed for each month, or part of a month, that the tax remains unpaid from the due date, until the tax is paid in full or a 25% maximum penalty is applied. The one-half of one percent rate increases to one percent if the tax remains unpaid 10 days after the IRS issues a notice of intent to levy.

In some cases, it is not a bad idea to negotiate an installment agreement with the IRS to pay off back taxes. For individuals who file by the return due date, the one-half of one percent rate decreases to one-quarter percent for any month in which an installment agreement is in effect.

Late Filers

Faced with the above penalties, some might choose to take a bury-your-head-in-the-sand approach to filing a tax return in the first place. However, the penalties for not filing at all or filing late are notably worse than those above.

The total late-filing penalty is usually 5 percent of the tax owed for each month, or part of a month that your return is late, up to five months (or 25% of the amount shown due on the return). Also, if a filer's return is over 60 days late, the minimum penalty for late filing is the smaller of $100 or 100 percent of the tax owed.

Finally, if the tax payer's failure to file is due to fraud, the penalty is 15% for each month or part of a month that the return is late, up to a maximum of 75%.

Combined Penalties

If both of the aforementioned failure-to-file and failure-to-pay penalties apply in any month, the 5% (or 15%) failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100% of the unpaid tax.

Frivolous Tax Submissions

Often suffered by "tax protesters" or those who adopt their arguments, the IRS may assess a penalty of $5,000 if someone files a frivolous tax return or other frivolous submission. A frivolous tax return is one that does not include enough information to figure the correct tax or that contains information clearly showing that the tax reported was substantially incorrect.

Individuals unsure about a particular tax strategy they are considering should take a look at this information from the IRS on frivolous returns, frivolous submissions, and a list of positions that are identified by the IRS as frivolous: "The Truth About Frivolous Tax Arguments".

Mistakes

You may have to pay a penalty if you file an erroneous claim for refund or credit. This occurs in circumstances where a taxpayer:

  1. Shows negligence or disregard of the rules or regulations, or
  2. Substantially understates their income tax.

The penalty is equal to 20% of the underpayment, unless the taxpayer adequately discloses a reasonable basis for the way they treated the item at issue, or their position was supported by substantial authority. 26 U.S.C. section 6662.

Civil Fraud

The penalties get significantly worse for intentional underpayments. If there is any underpayment of tax on your return due to fraud, a penalty of 75% of the underpayment due to fraud will be added to your tax. 26 U.S.C. section 6663.

Criminal Penalties

All of the above fall into the category of "civil" penalties, but the most severe penalties filers face are directed toward those who commit tax evasion, fraud, and similar offenses. Individuals who get caught committing tax fraud face the above noted 75% civil penalty, and additionally face substantial fines and jail time.

For example, attempting to evade or defeat tax under is a felony carrying a fine of up to $250,000 and imprisonment for up to 5 years. 26 U.S.C. section 7201. Making false statements on a tax return is also a felony risking the same fine and imprisonment for up to 3 years. 26 U.S.C. section 7206. If you are being investigated for a tax crime by the IRS, it is very important to retain an attorney who is familiar with both tax and criminal matters.

Interest

Although not a "penalty" in the traditional sense, a late filer or taxpayer who does not pay the entirety of the amount they owe will have to pay interest. Interest is charged on the amount of unpaid balance, penalties, and interest that has been charged to the tax account from the due date of the return until the date payment is made. The interest rate is determined every three months and is the federal short-term rate plus 3 percent. Furthermore, interest is compounded daily.

With this in mind, it should be noted that in many cases, the funds necessary to pay taxes can be borrowed at a lower effective rate than the combined IRS interest plus penalty rate.

Next Steps
Contact a qualified tax attorney to help you navigate
your federal and/or state tax issues.
(e.g., Chicago, IL or 60611)

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