When the IRS determines that a taxpayer has failed to meet their obligations for paying tax and filing returns, the taxpayer may be required to pay an IRS tax penalty in addition to taxes owed and interest fees. The dollar amounts of such penalties vary, but all IRS penalties are meant to be severe enough to deter people from attempting to skirt the tax laws.
The surefire way to avoid being assessed penalties is to carefully track and report all your income, submit estimated tax payments on time, and either file your annual returns and pay any tax you owe by the deadline or submit the proper IRS form to request an extension of time to file. Even if you receive notification of a tax penalty, however, all hope is not lost: you may be eligible to request penalty abatement.
Why Is the IRS Charging Me a Penalty?
There are many reasons that a taxpayer might incur a penalty, from honest mistakes to deliberate misrepresentations of income or deductions. However, the majority of penalties arise for one of three reasons:
1. Failure to File a Return or Pay Tax Owed by the Deadline
Unless you have been notified by the IRS that your request for an extension of time to file has been approved, federal law requires that you file all required annual returns and pay any tax due by the filing deadline (usually April 15). Failure to do one or the other is the surest way to incur an IRS penalty. Note that IRS guidelines plainly state that simply lacking the necessary funds will not be deemed a reasonable reason for failure to pay. It is also important to remember that if you receive an extension and file your return after the standard deadline but owe tax, you will be required to pay interest on the tax balance even though no penalty will be assessed.
2. Failure to Report Income
Except in cases where the taxpayer can provide evidence that the omission was an honest mistake rather than an intentional misrepresentation, the IRS takes a harsh view of underreporting of income. Penalties for this violation tend to be harsh.
3. Failure to Make Required Estimated Tax Payments
If you derive income from any source that doesn’t entail an employer withholding tax from your paychecks, you are required to make quarterly estimated tax payments. The general rule is that each payment must be at least the lower of 25% of your previous year’s total tax or 22.5% (one-fourth of 90%) of the tax you will owe for the present year. Of course, if you pay more than the minimum amount for any quarter, you may reduce a subsequent payment by the corresponding amount. More complicated formulas may be employed to determine quarterly payments if your income is irregular.
However they are calculated, your estimated tax payments must be made by the quarterly deadlines (usually April 15, June 15, and September 15 of the current year, along with January 15 of the next year). Failure to make timely estimated tax payments results in automatic penalties, even if the taxpayer pays all tax owed for the year by the annual deadline. Paying estimated tax is especially critical if you receive a large, one-time influx of income at some point during the year.
What Is Penalty Abatement and What Are the Methods for Pursuing It?
In plain English, penalty abatement is a reduction or elimination of IRS penalties. Abatement is most often offered when a taxpayer can demonstrate that there was reasonable cause for a failure to pay taxes (estimated or year-end) or to file required returns on time.
Examples of Reasonable Cause
The IRS defines “reasonable cause” as any circumstance that would make it extraordinarily difficult or even impossible for a taxpayer to meet their Federal tax obligations in spite of conscientious efforts to do so. The most commonly cited examples of reasonable cause are:
- Fire, flood, other natural disaster, or other disturbances such as vandalism or theft
- Inability to attain records due to disaster or non-cooperation of third parties
- Death, incapacitation, or involuntary absence
- Reliance on the advice of a competent tax professional
In order to seek a judgment of reasonable cause from the IRS, it will be necessary to provide detailed documentation of the event that occurred and a clear explanation of how it prevented filing of a return or payment of taxes. Assembling the necessary evidence and presenting it effectively can be complicated.
First-Time Abatement and Other Exceptions
Taxpayers may also qualify for First-Time Penalty Abatement if they meet certain requirements related to a “clean record” of past tax payment. Even if your situation does not seem to satisfy the requirements of reasonable cause or meet the criteria for first-time abatement, a tax professional may be able to provide guidance on other approaches to pursuing penalty abatement.
Is Abatement Also Available for Interest Charges?
That depends on the basis for the interest charges. If interest accumulates on an assessed penalty amount, but the penalty is later reduced or eliminated, the associated interest will be reduced or eliminated as well. However, interest charges associated with owed tax rarely qualify for abatement.
Conclusion
The best policy is of course to conduct your tax-related affairs in such a way that you never have to think about IRS penalties. But if a penalty notification darkens your doorstep, do not compound the problem by ignoring it or protesting in anger. A thoughtful, proactive approach to pursuing penalty abatement can bring even the biggest tax problems down to size.
