IRS Penalties and Interest FAQs
Accuracy Penalties
You may have to pay an accuracy-related penalty if you underpay your tax because: 1) You show negligence or disregard of the rules or regulations (25% penalty), 2) You substantially understate your income tax (greater that 25%) (25% penalty), 3) You claim tax benefits for a transaction that lacks economic substance (40% penalty), or 4) You fail to disclose a foreign financial asset (40% penalty).
Fraud Penalties
If the IRS can prove that you fraudulently omitted or underreported income, they may access a 75 % penalty, calculated on the omitted or underreported income.
While rarely used, if the IRS can prove that you fraudulently failed to file a return, it can assess a 15% per month penalty, for up to for up to five months. This would be a 75% penalty assessed against any outstanding tax liability.
Failure to Pay Penalties
Penalties for unpaid taxes are one half of a percent of the taxes owed for each month the liability is outstanding. The maximum penalty is 25% of the outstanding balance. The penalty will increase to 1% if the tax remains unpaid 10 days or more after the IRS issues a Notice of Intent to Levy CP 504. The penalty will decrease to a quarter of a percent for any month in which an installment agreement is in effect. The penalty starts on the day after the original due date, April 16 for individual tax returns. It is imposed on the unpaid balance and added on the 16th day of each month thereafter. This penalty is imposed on any portion of a monthly and is not prorated daily.
Late Filing Penalties
If you do not file your return by the due date (including extensions), you may be subject to a failure-to-file penalty. The penalty is usually 5% for each month or part of a month that a return is late, but not more than 25%. The penalty is based on any an outstanding tax liability.extensions).
Combined Penalties
If you are subject to both the late filing and failure to pay penalties, the IRS can impose a combined penalty of 5% per month, which is less than the combined penalties. The combined penalty is based on the unpaid tax balance for each month your return is late. When you reach 25%, after 5 months, the failure to file penalty has capped. The failure-to-pay portion of the combined penalty continues at one half of one percent per month until it reaches a total of 22½%. Thus, the maximum combined penalty is 47½ %.
Note that tax penalties DO NOT include charges for interest, which never stop until the balance is paid in full.
Note: The Failure to file, failure to pay, or the combined penalty can be stacked. They can be imposed in addition to other penalties such as accuracy or fraud penalties.
Can IRS Reduce or Eliminate Penalties?
The IRS can reduce or eliminated (Abate) a penalty for a reasonable cause, if you request it. About one-third of IRS-imposed penalties are later canceled (abated). The key here is you must formally request it. The IRS will not abate a penalty voluntarily!
Can IRS Reduce or Eliminate Interest?
Interest assessments are rarely cancelled. By law, interest can be only be canceled if it was erroneously applied, was due to lengthy IRS delays, or caused by documented advice of an IRS agent. Note: IRS will rarely put their advice in writing.
So What Can I Do to Get a Penalty Abated?
The key to having a penalty abated is to show “reasonable cause”. Reasonable cause is explain in the Internal Revenue Manual (IRS Policy Statement P-2-7) which says:
Any sound reason advanced by a taxpayer as the cause for delay in filing a return, making deposits … or paying tax when due will be carefully analyzed …. Examples of … reasonable cause:
- Death or serious illness of the taxpayer or … immediate family. In the case of a corporation, estate, [or] trust … death or serious illness must have been of an individual having sole authority to execute the return or make the deposit or payment.
- Unavoidable absence of the taxpayer ….
- Destruction by fire or other casualty of the taxpayer’s place of business or records.
- Taxpayer was unable to determine amount of deposit of tax due for reasons beyond taxpayer’s control….
- Taxpayer’s ability to make deposits or payments has been materially impaired by civil disturbances.
- Lack of funds is an acceptable reasonable cause for failure to pay any tax or make a deposit … only when a taxpayer can demonstrate the lack of funds occurred despite the exercise of ordinary business care and prudence.
- Other explanations may be acceptable …. Acceptable explanations of delinquency are not limited …. Any reason … established that the taxpayer exercised ordinary business care and prudence but was nevertheless unable to comply within the prescribed time will be accepted as reasonable cause.
How Do I Petition For A Penalty Abatement?
The abatement request has to be done by mail, by either letter or Form 843 Claim for Refund and Request for Abatement. Attach a copy of the IRS notice(s) showing the penalty.
Supporting Document for Reasonable Cause: You absolute must provide supporting documentation for your reasonable cause argument. Without this supporting documentation, your chance of success will be seriously diminished. Examples of supporting document would be; 1) A letter from a doctor’s regarding a period of mental disability, 2) Fire department report and insurance claim as proof of a fire that destroyed record, 3) The death certificate of a family member that cause emotional distress.
DO NOT send the original documents to the IRS. The IRS is notorious for losing taxpayer correspondence. If you received another notice before receiving a response (likely), contact the IRS and ask for a hold on the escalation of collections.
If My Abatement Request Is Rejected, What Are My Options?
If the IRS officially rejects your abatement request, you have four options;
1) Send An Appeal Letter. Clearly state why you disagree with the decision quoting the Internal Revenue Manual. At this point you probably want to get the help of a Certified Tax Resolution Specialist. The disadvantage to the appeal letter, if denied, there is no future appeal process.
2) Request a transfer to a local Revenue Officer. This is a letter to the IRS requesting that your case be transferred to a local Revenue Officer. Again, I would not recommend you try this on your own; it’s time to get some help.
3) Pay the penalty and file a claim for refund. Using Form 843, Claim for Refund and Request for Abatement. Mark the area for explanation “See Attached” and attach a letter of explanation similar to the one used for the original abatement request. This is even more complicated than the simple appeal letter and likely should be handled by a professional. The Form 843 claim does have an advantage over the appeal letter, if denied, you can sue in a U.S. District Court or the court of claims.
4) Pay the Balance. While not the best option, it is an option.
Abating Interest
If you receive an abatement of the penalty, the interest on the penalty liability should be removed also. This is anything but automatic. You will need to monitor its.The IRS can abatement interest ONLY under the following circumstances:
- (a) The IRS was in error in charging interest.
- (b) The IRS incorrectly sent you a refund, then realize it was in error, requested the money back and received it immediately. Note the refund cannot due to your actions.
- (c) The interest resulted from delays of the IRS in performing ministerial acts. The exception for ministerial acts does not cover interest while you challenge a bill or while the IRS audits you, or while you appeal or go to tax court. This interest cannot be abated, unless you win your case.
- (d) The interest accrued more than 18 months after the original due date of a tax return or the date the return was filed, and the IRS did not notify you that additional tax was due during that period.
- (e) The interest accrued on a return you filed late because you were living in a federally declared disaster area when the return was due.
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