Things don’t go as planned when it comes to filing your tax returns and paying them on time. Even if you abide by the rules, you might face an IRS tax penalty for missing a tax filing deadline, underestimating your quarterly payments, or bouncing a cheque. Mistakes do happen, but it helps to know the types of penalties the IRS charges and how to avoid IRS penalties. Here are some common tax penalties the IRS charges taxpayers and tips for avoiding them.
Failure to File
This year, tax returns were due on 17th May 2021 during the tax season. However, if you requested an extension, it gives you until 15th October to file your return. If you don’t request an extension or miss your extended due date, the IRS charges a penalty.
The tax penalty is generally 5% of the unpaid tax for each month or part of a month when your return is late. However, it caps at 25% [5 months] of your balance.
If your return late for more than 60 days, a minimum penalty applies. Further, the minimum penalty is either $435 or 100% of the tax owed, whichever amount is less, for returns due after 01/01/2020.
Please make sure to file your return by the due date [or extended due date] even if you cannot pay the due balance in order to avoid IRS penalties. You have a little more space if you are expecting a refund. In that case, the IRS will not charge a failure to file a penalty if you file your tax return late. But remember, you can lose your refund if you do not file your return within three years of the original due date.
Failure to Pay
Whether you file your tax return on time or request an extension, the IRS needs you to pay the tax due by the filing deadline. However, if you don’t pay what you owe by that date, the IRS charges a failure to pay the penalty.
Although his tax penalty is 0.5% of the tax you owe per month, it also caps at 25% of the tax due. If you set up an IRS installment agreement, the IRS will reduce your failure to pay the penalty to 0.25% of the tax you owe while the installment agreement is effective.
Even if you pay the due balance before the month ends, fail to file a penalty, and fail to pay, the penalty is both charged for a whole month. When both the penalties apply to the same month, the failure to file penalty is reduced by the amount of the failure to pay the penalty so that the maximum combined failure to file and failure to pay the penalty is 5% for any month.
For avoiding or at least minimizing failures for paying penalties, you must pay your tax in full by the deadline, even if you request an extension. If you owe more than you can actually afford, pay as much as possible by the deadline and then pay the rest as soon as possible.
Nevertheless, you should look forward to requesting an installment agreement if you cannot pay the due amount within a few months of the due date.
Failure to Pay Estimated Tax
The IRS has a “pay as you go” system. This means you are supposed to pay taxes throughout the year as you earn or receive income instead of sending a big lump sum to the IRS at the end of the year.
If you owe more than $1,000 while calculating your taxes, you could be subject to a penalty. For avoiding this, you must make payments throughout the year through tax withholding from your paycheck or estimated quarterly payments, or both.
The IRS calculates this penalty by calculating out how much you should have paid each quarter and multiplying the difference between what you have paid and what you should have paid by the effective interest rate for that period. Consequently, you can have a penalty for one quarter, but not the others.
To minimize or avoid estimated tax penalties, adjust your tax withholding from your paycheck, calculate your tax bill, and make estimated quarterly payments. Quarterly estimates are usually due on 15th April/June/September and January.
If one or more of those dates fall on a weekend or national holiday, the deadline is pushed back to the next business day. Moreover, the IRS offers two “safe harbor” methods for identifying whether you are subject to a penalty or not.
If you meet one of these safe harbor requirements, the IRS will not charge a tax penalty, even if you owe more than $1,000 at the year-end.
- 90% of the tax you owe for the current year: Estimate what you will owe and pay at least 90% of this amount quarterly or through paycheck withholding.
- 100% or 110% of last year’s tax bill: You have to pay 100% of the tax shown on your previous year’s tax return before applying estimated payments, refundable tax credits, or withholding. If your gross income is more than $150,000 (or $75,000 if you are married and file a separate tax return from your spouse), the safe harbor is 110% of your previous year’s tax.
If you write a check to cover your tax bill but at the same time don’t have sufficient funds in your bank account to cover it, your bank may dishonor the check.
The IRS charges a dishonored check penalty of 2% of the check’s total amount unless it is less than $1,250. In such a case, the penalty is $25 or the payment amount, whichever is less.
Make sure to have sufficient funds in your account to cover your payment before mailing the check, or opt for overdraft protection with your bank to avoid dishonored check penalties.
How to Avoid IRS Penalties?
In a perfect world, you would never have to deal with IRS penalties. In reality, tax penalties are a reality for most people. Luckily, the IRS is often willing to work with people who make mistakes. This process is known as penalty abatement.
There are two clauses for the IRS to consider penalty abatement.
If you didn’t file on time or pay the tax you owe due to unfavorable circumstances, the IRS might waive your penalties. For instance, a reasonable cause might include a house fire, illness, natural disaster, or an immediate family member’s death.
First-Time Penalty Abatement
If you are generally on top of your tax filing responsibilities but just missed the payment due date, the IRS may offer you a one-time favor. This is a good way to avoid IRS penalties if you have a good record.
You must have filed all of your tax returns for qualifying, set up an installment agreement with the IRS, or paid your outstanding balance, and have no previous penalties in the last three years.
You can file taxes hassle-free by contacting your nearest tax agency. They will also help you find out all the tax forms you need. Further, they will help you uncover all the tax deductions and credits you are eligible for.