IRS Penalties Most Likely to Affect Small Businesses
© by Fred W. Daily
The number of penalties available to the IRS to punish wrongdoers is
staggering. This section covers the ones that are most likely to be imposed on a small
The IRS can hit you with a 20% penalty if it finds you were
negligent (unreasonably careless) or substantially understated your taxes. You typically
incur this "accuracy related" penalty when you cant prove a deduction on
an audit, or you forgot to report all of your income and the IRS discovers it.
If the IRS finds that you underreported your income with a
fraudulent intent (it doesnt look like a mistake to the IRS), you can be fined 75%
of the amount of the resulting tax deficiency. Dont worry too much about this civil
(noncriminal) tax fraud penalty -- its imposed in less than 2% of all audits. (You
may also be charged with the crime of tax fraud, which is even rarer).
Failure to Pay on Time
The IRS usually adds a penalty of 1/2% to 1% per month to an income
tax bill thats not paid on time. This penalty is automatically tacked on by the IRS
computer whenever you file a return but dont pay the full amount owed, or pay it
Late payment penalties for failing to make payroll tax deposits on time are
If youre late in filing certain income tax returns or other
forms, the IRS can penalize you an additional 5% per month on any balance due. However,
this penalty can be applied only for the first five months following the returns due
date, up to a 25% maximum charge.
Filing and Paying Late
A special rule applies if you both file late and underpay. The IRS
can (and probably will) impose a "combined penalty" of 25% of the amount owed if
you dont pay in the first five months after the return and tax are due. After five
months, the "failure to pay" penalty continues at 1/2% per month until the two
penalties reach a combined maximum of 47-1/2%. This is a slightly lower (2-1/2% less
overall) penalty than if the two penalties were applied separately. Wow, those IRS folks
sure can be generous.
IRS penalties are "stackable." Late filing and paying penalties can
be imposed by the IRS in addition to any other penalties, such as for fraud and filing an
inaccurate return. Congress and the IRS believes the more the merrier when it comes to
Underpaying Estimated Taxes
Undoubtedly, many of you will get hit with the estimated tax
penalty. I know I have been, for whatever that is worth to you. All self-employed
individuals must estimate their income tax for the year and pay it in quarterly
installments throughout the year. You must come pretty close to paying everything you will
owe, although you dont have to guess the amount precisely. Here are the rules:
The penalty for not complying is currently calculated at a 9% annual rate on
the amount that was underpaid for each quarter. Quarterly payments should be equal -- you
cant play catch-up with larger payments later in the year and still avoid this
By: Frederick W. Daily, Tax Attorney,
John Raymond, Bankruptcy Attorney, and
Allan H. Rosenthal, paralegal.
All of the three have offices in San Francisco.
(This article was originally written for tax
practitioners who represent clients before the IRS. But the information
presented here is valuable for all taxpayers.)
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