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.