How to Prevent or Avoid IRS Penalties this Tax Season

by Guest Contributor · 12 comments

With a lackluster economy, unemployment rising, and tax revenues plunging, Uncle Sam would love for you to generate more revenue for him. In fact, the IRS with increased funding has more personnel and capital than ever before, and will issue a penalty whenever you fail to file, fail to pay, or forget to file certain tax forms. Penalties are typically assessed by computers, but IRS personnel can add them to your tax bill as well. During these tough times, there are many things you can do to prevent unnecessary penalties. Below, you find the most common penalties imposed by the IRS and ways you can avoid them.

  • Prevent an Unfiled Tax Return – If you cannot pay your total tax bill, still file a tax return. If you fail to file the return, you will be charged five percent per month (up to 25% percent total) on the unpaid tax balance which will only lead to larger tax liabilities. If there are any penalties to avoid, the failure to file penalty is at the top of the list. Even if you do not owe any taxes, there are still many drawbacks to not filing.
  • Request An Extension If Needed – If you cannot file by April 15th, you can request an extension by filling out IRS form 4868. This automatic extension will give you until October 15th, 2010 to get your tax return filed. The benefit here again is to avoid the “failure to file” penalty. However, the caveat is that this is an extension to file, but not pay.
  • Pay As Much As You Can – If you cannot pay your total tax bill, pay as much as you can to reduce the failure to pay penalty when filing your return. If you are filing a tax extension, it is important to make sure that the IRS has at least ninety percent of your total tax bill. If the IRS does not have at least ninety percent of your actual tax liability, a failure to pay penalty will become applicable on the remaining balance. This penalty starts at a rate of 0.5% per month and can increase to 1% per month if you don’t pay and 10 days have passed after the IRS issues a notice of intent to levy (notice to seize your wages, bank, or property). In addition to the failure to pay penalty, there is an interest rate compounded monthly you must pay on the unpaid balance which for individuals currently stands at four percent (this interest rate can change every quarter as it is influenced by the federal short term interest rate). If you know you will not be able to pay all of your taxes, apply for an IRS Installment Agreement (apply here with the Online Payment Agreement), which will give you the ability to pay off your taxes over a series of monthly payments. The benefit is that the failure to pay penalty could be reduced by 50%.
  • Be Accurate and Cognizant – If you are negligent or you substantially understate your tax bill, and you are audited, the IRS can impose a 20% accuracy-related tax penalty on the total underpayment amount. This penalty can not be more than twenty percent but as you can see it is a bit excessive in comparison to other penalties. The moral of the story here, whether you are working with a tax professional or using a software program, is to make sure the information you provide is accurate and not exaggerated.
  • Do Not Be Malicious – Yes, no one likes to pay taxes, but fraudulently under-reporting income will lead you into deep water with the IRS. How deep? How does a 75% percent penalty on the tax underpayment amount sound? In fact, this is the harshest of all penalties the IRS will impose, so don’t understate your income!

Overall, the IRS imposes penalties to make sure taxpayers pay, file, be accurate, and honest. Now that you have an understanding of how these penalties work and what you can do to avoid or mitigate them, you can prevent Uncle Sam from getting more than his fair share. Of course, these penalties are to prevent people from intentionally gaming the system, and you can abate these penalties or get them removed or reduced if you have reasonable cause under certain situations. Basically, the IRS will work with you if you are honest, so don’t worry too much.

This is a guest post from Manny Davis, tax accountant and writer for Back Taxes Help, which is a tax settlement firm that specializes in helping taxpayers with major state and Federal tax problems including back tax returns, tax liens, tax levies, irs tax penalties, tax audits and more.

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{ read the comments below or add one }

  • chicagoroots says:

    If my home is in foreclosure, shouold I notify the IRS as I am also being audited?

  • Gosh, I hate taxes. This post reminds me about how horrible our tax system is.

  • Wes Masters says:

    One other thing to add regarding extensions – your best bet is to file one online with an authorized e-file provider. That way you are guaranteed to get a response from the IRS. Sending form 4868 thru the mail isn’t a good idea b/c the IRS will never acknowledge they received your request. That means you could be accumulating late fees without knowing it.

  • Jeff says:

    Personally, I believe that if it wasn’t important enough to enforce or catch on a “good” year then it shouldn’t be enforced on a “bad” year because the government entity (from the Feds on down) needs the cash.

    Locally: Uncovered loads to the dump fee enforced, for the first time since it was put on the books 5 years ago.
    More speeding tickets.
    “Better” enforcement of ordinances, permit laws, etc.

    IRS is less forgiving. Of course they are under pressure to generate more cash, just like cops are under more pressure to generate higher quotas.

    I’m not blaming the individuals that are issuing the citations, etc. (except for the “supercops”) but really, why have a law on the books if it’s just there to generate income for the state in bad times and never enforced in other times?

  • john says:

    Also if you think the irs is not going to audit more this year with more personnel then I do not know what to tell you.

  • john says:

    Stop assuming things. The author is stating facts. The irs has more personnel and money with increased funding that I think his main point is do not try to game the system because federal government needs money. He is not questioning the integrity of employees from what I read he is giving advice to avoid penalties.

  • Imani says:

    None of this is new or due to the economy. The way this is written, it makes it seem like IRS is looking for ways to generate money above and beyond what is lawfully due and owed. NOT TRUE.

    Obviously, the author has a dog in this fight and is looking to game the system (induce fear) for his own benefit.

    • Sandy says:

      I don’t know if they are necessarily looking for ways to make more money, but I’m sure there’s more pressure for the auditors to be stricter than they are in the “good” years.

      • Imani says:

        Curious to know what makes you think so. Basically, that seems to call into question the integrity of IRS employees. So when can we depend on impartial, and fair application of the law? In “good years”? When are the good years? The implication re the IRS is disturbing. I wonder how they would respond.

        • MoneyNing says:

          I think Sandy is just saying that it’s less likely that IRS employees would let you go if you did something wrong. It’s like a cop more likely to issue a ticket instead of telling you not to do it again and let you go if he just got out of the police station with the chief giving a speech about the need for more funding in their district.

          In the same way, the guest author is more inclined to talk about problems you can encounter with filing taxes rather than how easy it is to file online by yourself. It’s just human nature and I don’t think this natural trait is extreme enough to cross the line of “integrity”.

        • Sandy says:

          Sorry that I offended you.

          I just mean that it’s human nature, as David said. It’s like the times when my company is in trouble, we work harder to make sure there are less mistakes.

          In the case of the IRS, when the government needs more money, I’m sure the auditors are more detailed in their search to find more mistakes that people make.

    • Manny Davis says:

      I am sorry if this post offended anyone. I was not insinuating that the”IRS is looking for ways to generate money above and beyond what is lawfully due and owed.” David is right. My point was that during these tough times the IRS is less inclined to make exceptions for individuals who make mistakes.

      Also, regarding your point as to induce fear so that I can somehow gain is misguided. My company specifically focuses on individuals who run into major problems with the IRS. Therefore, if I am giving advice to help individuals avoid major problems or penalties, I am not to gain.

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