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Every IRS Penalty You Should Know About—and How to Avoid Them

By Ryan Smith on December 9, 2017

It’s normal to be afraid of the IRS. Even the names of their employees sound intimidating—IRS agent. It sounds like a secret agent who just might show up at your door and take you to prison if you make a mistake on your taxes.

Taxes are serious. But they feel a lot less scary when you fully understand the possible penalties that lay before you. Short of having criminal intentions, you probably won’t be thrown in jail or have your small business taken away.

Here are the IRS penalties for the most common, non-criminal offenses.

Penalties for missing a deadline

Filing your taxes late

First, you can always file for a tax extension (here’s how).

But if you file your taxes more than 60 days past the due date or extension date, the minimum penalty is $205, or if you owe less than that, then 100 percent of your owed amount. However, that’s only if you file right after the 60 day mark.

For every month after that you don’t file, your fine accumulates at a rate of 5 percent of unpaid tax per month.

Even if you know you can’t pay your bill in full, you should still file your taxes and pay what you can. The IRS interest adds up fast.

Paying your taxes late

You will have to pay an additional 0.5 percent of unpaid tax every month until you pay your original tax bill, up to a maximum 25 percent of your total tax bill.

Be warned, this penalty still applies even if you sent in a check on time, but the check bounced.

Combined penalty for filing late and paying late

Thankfully, these two penalties don’t stack. If you are late to both, you will only pay the 5 percent per month interest fine.

Paying your taxes late, after an Issuance of Notice

If the IRS finds that you owe more in taxes than you originally calculated, they’ll send an Issuance of Notice to ask for the additional payment. After that, you have 21 calendar days to pay the additional amount, otherwise 0.5 percent interest per month will begin to accumulate.

Submitting a form late

If you’re late returning a W2 (for employees) or a 1099 (for contractors), the fine is a maximum of $50.

If you’re late returning a 1065 form (for partnerships) or a 1120S form (for S-Corps), the fine is a maximum of $195 a month per partner.

Penalties for making a mistake

Calculating your owed taxes too low

If you substantially understate how much tax you owe, or the IRS finds you were negligent in an aspect of your taxes (ie. it wasn’t just a small mistake), the penalty is a 20-40 percent increase in taxes owed.

Calculating employee taxes incorrectly

There is a 100 percent penalty on all unpaid federal employee taxes. In other words, you’ll have to pay twice for the employee taxes you don’t pay the first time. The two common scenarios for this are not reporting employee wages through your payroll provider, and not reporting employee tip income.

When does it become criminal?

If the IRS finds that your mistake goes beyond negligence, into the territory of intentionally lying and filing a false return, then you have committed a criminal offense and could have your property seized, or serve jail time. The IRS isn’t playing around.

What could trigger an audit?

IRS audits are triggered for one of three reasons:

  1. Random selection through the IRS system
  2. Computer screening—returns that fall outside the IRS “norms” are flagged
  3. Related examinations—if your tax return is connected to another taxpayer who is being audited, you may be audited just by association

Small business signals that could trigger an audit

  • Failure to report income that has already been reported to the IRS (on W2s or 1099s)
  • Taking suspiciously big deductions—for instance, deducting 100 percent of your personal car use
  • Misclassifying your employees
  • Failing to issue information returns—W2s, 1099s, etc.

What happens if I don’t keep all my receipts?

If you are audited, you will need to provide receipts or some other form of proof for your deductions. If you don’t, you may not be able to deduct those expenses. Sole proprietors have to be especially careful about this, as they’re three times more likely to be audited compared to other taxpayers.

What happens if I do get audited?

In the movies, an audit is where an IRS agent shows up at your door and leaves no stone unturned in your business. That is rare in real life—it’s called a field audit.

More commonly, one of three things will happen if you do get audited.

  1. Correspondence audit. The IRS will ask for further information over email or physical mail. Usually this is caused by an omission of income, or another serious error. You’ll either have to pay the amount detailed in the correspondence, dispute it with a lawyer, and/or provide the necessary documents such as receipts for deductions, or missing W2 forms
  2. Office audit. The IRS may want to interview you in person. You will have to go into the IRS office. We recommend you bring a CPA or a lawyer. You may end up paying more in taxes or penalties, or if you dispute it, not having to do anything at all.
  3. Line-by-line audit. This is chosen at random. The IRS goes through each line of your tax return so they can establish the “norms” that trigger future audits.

As long as you comply (or legally dispute), provide sufficient proof where necessary, pay the fines, and demonstrate that you did not have criminal intent, you will be fine.

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This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.

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