The IRS assessed and collected nearly $60 billion from individual, estate, and trust income tax fines in 2022. This staggering statistic indicates that civil penalties significantly impact business entities and individual taxpayers.
These penalties are assessed for tax code violations, and the IRS uses them to discourage taxpayers from underpaying their tax liabilities or filing their returns after the filing deadline.
Rather than taking each case to court, the IRS issues monetary fines whenever the offense doesn’t warrant criminal charges.
We’ll review the most common IRS civil penalties to help you understand what they are and how they can impact you.
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What Are Civil Penalties?
Depending on the gravity of the tax code violation, the IRS can assess a civil or criminal penalty. Taxpayers charged with a civil penalty only have to pay a fee, usually a percentage of outstanding tax debt.
On the other hand, criminal penalties involve a criminal investigation conducted by the IRS’s special agents. After the investigation, the findings are referred to the Department of Justice, and the taxpayer faces a potential jail sentence.
Although they’re not as harsh as criminal penalties, civil penalties can still significantly impact taxpayers’ finances. These penalties don’t come with a flat fee, meaning that the amount you’ll have to pay depends on the factors below:
- Tax code violation.
- Outstanding debt and percentage for the assessed penalty.
- The time that passes before you pay the debt and the fee.
All penalty percentages are unfavorable for taxpayers because they increase as time passes, and you’ll accrue a considerable debt if you neglect them.
The Most Common Penalties for Individual Taxpayers
The IRS has over 140 civil penalties for different tax violations. You’re unlikely to encounter most of these penalties as a fully employed individual taxpayer.
In most cases, the IRS utilizes only a handful of civil penalties to fine individual taxpayers who fail to comply with the tax code. Let’s look at some of the most common penalties you may face as an individual taxpayer.
1. Failure to File Penalty
It’s by far the most common penalty taxpayers encounter. Missing the filing deadline, usually April 15, but the date might change if it falls on a weekend or a holiday. It triggers the failure to file a penalty that includes 5% of the tax liability plus interest.
The penalty applies each month your tax return is overdue. The percentage of the tax liability charged to your account increases from 5% to 25% after five months.
The IRS also charges a 100% penalty or $450 (whichever is the lesser amount) if a tax return is filed two months after the deadline. There’s no statute of limitations for late returns, so you may have to pay multiple late-filing penalties if you don’t file tax returns for several years.
2. Late Payment Penalties
You must pay the entire debt for the current tax year before the deadline. If you don’t, the IRS will charge a late payment penalty of 0.5% of the balance due to your account.
If you don’t settle your tax debt, the IRS will send you CP504 Notice thirty days before placing a federal lien on your assets. The late payment penalty will increase to 1% of the balance due per month ten days after you get this notice from the IRS.
3. Audit Penalties
Claiming tax credits you’re ineligible for or underreporting taxable income are some of the most common reasons for an IRS audit.
The agency reviews a taxpayer’s tax information during this process. It assesses 40% of the tax debt penalty if the investigation determines a deliberate attempt to avoid tax responsibilities.
Hence, you may face an audit penalty if the information on your return is inaccurate and you fail to take the necessary steps to correct it.
Tax sheltering, understating back taxes by more than 10% of the entire liability, or overstating the value of a gift are also reasons the IRS may assess audit penalties.
4. Accuracy Penalties
Tax returns containing incorrect information can be subject to civil penalties, so you might get an accuracy fine for making a clerical or math error on a return.
The IRS often corrects minor errors without notifying taxpayers and allows them to file amended tax returns to correct mistakes and avoid penalties.
The accuracy fine is 20% of the amount you owe to the IRS, and you may have to pay it if you fail to report a foreign asset or make a math error that significantly lowers your tax liability.
6. Civil Penalties for Frivolous Returns
A frivolous tax return is a return that presents frivolous tax arguments. Such arguments prevent the IRS from determining the accuracy of the self-assessment and delay the processing of a return.
Consequently, the IRS uses civil penalties that range from $500 to $5000 to discourage taxpayers from filing frivolous tax returns.
Common Civil Penalties for Business Entities
Remote workers, independent contractors, and small business owners can face civil penalties most taxpayers who work as full-time employees are unlikely to face. Here are some of the most common civil penalties the IRS assesses for business entities.
1. Failure to File Forms W2 and W3
Regardless of their type or size, all businesses must send Forms W2 and W3 to report wages and withholding amounts for their employees.
Your business will incur this civil penalty if you don’t send Form W2 to your employees or file it with the IRS. The fine is $50 for each form filed up to thirty days after the deadline, and it increases to $100 for forms filed between March 1 and August 1.
The penalty for filing Forms W2 or W3 after August 1 is $260 per turn. The maximum annual fee for a small business that fails to file these forms is $187,500 or $536,000, depending on the rate.
Businesses that fail to remit the taxes they withhold from their employee’s wages to the IRS can face civil penalties.
2. Underpaying Estimated Taxes
Shareholders in S Corporations, sole proprietors, and independent contractors must pay estimated tax.
The IRS assesses the civil penalty for missed estimated tax payments based on the amount due, the number of missed payments, and other factors.
You can avoid this penalty by paying 90% of the estimated due amount but remember that you may still be fined if you don’t pay taxes in equal installments. The IRS doesn’t penalize overpaying estimated taxes.
3. Tax Fraud Penalties
Taxpayers who deliberately provide inaccurate information on tax returns risk much more than paying steep penalties.
The IRS will charge 75% of the balance civil penalty and initiate an investigation that can result in an indictment if their agents prove that a taxpayer underreported income on purpose or deliberately used fraudulent information on a return to evade federal taxes.
The maximum jail sentence for tax fraud is five years.
Taking Preemptive Action to Prevent Civil Penalties
For most taxpayers, the best way to avoid civil penalties is to file tax returns and pay taxes on time. The IRS may still fine you if you file a return on time but fail to pay the outstanding tax debt.
So, checking the filing deadline every year and ensuring you don’t owe additional taxes to the IRS is usually enough to avoid civil penalties.
Estimated taxes are paid in four quarterly installments. The first installment is due on April 15, while other installments are due by the same date in June, September, and January of the following year.
Remember to pay the tax liability before the April deadline, even if you apply for a tax extension.
Using tax software to a file return will eliminate the chances of making a math error and facing a potential accuracy civil penalty.
Seeking Civil Penalty Relief
Taxpayers who cannot pay civil penalties charged due to failure to file a return on time or late payments can request back tax assistance from the IRS.
The agency can agree to waive a civil penalty if you meet certain criteria. For instance, if you’re unemployed for over a month when you apply for penalty relief, the IRS may assign the Currently Not Collectible status to your account and allow you to postpone paying the tax debt.
Applying for an installment agreement will reduce the percentage-based penalty assigned to our account and enable you to repay the tax liability under $50,000 in up to four months.
The IRS might waive a civil penalty if a taxpayer violated the tax code due to a natural disaster, the death of a family member, or a filing system error.
Frequently Asked Questions
Paying the fine immediately isn’t always the best course of action. Sometimes it’s necessary to check if the penalty was assessed to your account by mistake and if you qualify for penalty relief before paying the amount due to the IRS.
The daily interest charge for due taxes is three percentage points. The interest accrues from the return’s filing deadline until the debt is paid.
Your case will go to a tax court because the IRS can sue you to collect an unpaid debt. The value of assets the IRS collects will include the penalty and interest on the amount you owe. However, you won’t face criminal charges unless accused of tax evasion.
The IRS will correct an accidental math error while processing your return, so in most cases, you won’t have to pay a civil penalty if you underreport your income by mistake.
You can also correct the reported amount by filing an amended return before the filing deadline to avoid a civil penalty.
Reducing the Impact of IRS Civil Penalties on Your Finances
Your tax debt will increase at a dizzying rate if the IRS assesses a civil penalty to your account, so choosing to ignore the fine is the worst thing you can do. However, you shouldn’t pay these fines before understanding why the penalty was added to your tax debt.
Your hands aren’t tied because there are several things you can do to lessen the financial blow of civil penalties.
Please visit choicerelief.com or call 866-8000-TAX to speak with a CPA who can recommend the best way to deal with an IRS civil penalty.
Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
