In 2023, the IRS issued more than 45 million penalties to taxpayers. Most penalties are for late payment of taxes, late filing, and for making errors on a tax return.
There are more than 150 different IRS penalties. However, 4 penalties make up 96% of all penalties assessed. The most common penalties are:
- Late payment penalties: the failure to pay penalty is the most common penalty for taxpayers. Almost ½ of all penalties are for failure to pay. The failure to pay penalty is 0.5% per month, and is capped at 25% in total. The penalty is calculated based on the amount of unpaid taxes and how long the taxes remain unpaid. The failure to pay penalty can increase to 1.0% per month if a taxpayer does not pay their tax bill within 10 days of getting an IRS collection notice (generally IRS notice CP504). The failure to pay penalty can be reduced to 0.25% per month if a taxpayer obtains a payment plan on a timely filed return before they receive a collection notice.
- failure to pay taxes throughout the year: the estimated tax penalty can apply if a taxpayer does not pay their tax bill throughout the year through federal tax withholding in their paycheck (wage earner) or with quarterly estimated tax payments. The estimated tax penalty represents lost interest to the government for late payments throughout the year. A taxpayer can avoid the estimated tax penalty by owing less than $1,000 on their filed return or by paying at least 90% of the tax shown on the return for the year or 100% of the tax shown on the prior year return, whichever is less. Estimated tax penalties make up over 1/3rd of all IRS penalties each year.
- Late filing penalties: the failure to file penalty applies to individual taxpayers when they do not file by the deadline to file (including extensions) and have a balance owed with the return. The failure to file penalty is 5% per month, up to 25% in total. About 10% of all IRS penalties are for late filing. S corporations and partnerships can also incur a late filing penalty even though they do not have a tax liability.
- Accuracy-related penalties for errors made on a tax return: taxpayers who do not accurately report their tax liability on their return can be subject to an accuracy related penalty. The accuracy penalty is usually for negligence or substantial understatement of tax. The amount of an accuracy-related penalty equals 20% of the portion of the underpayment attributable to the taxpayer’s negligence or disregard of rules or regulations or to a substantial understatement. The IRS imposes an accuracy penalty during an audit based on the taxpayer’s reasonable attempt to comply and report properly. This is a facts and circumstances test based on a number of factors the IRS auditor will consider during the audit. The IRS can also issue an accuracy penalty in their Automated Underreporter (i.e., IRS income matching or CP2000 program). CP2000s are not audits, but the IRS automatically proposes an accuracy penalty assessment based on prior underreporter or meeting the substantial understatement threshold. The number of accuracy penalties vary each year, depending on IRS volume of audits and CP2000 notices. Normally, accuracy penalties represent about 2% of all IRS penalties.
These four penalties make up 96% of all IRS penalties. There are many other IRS penalties which generally are for late filing, late payment, or inaccurate filings for one of the various tax returns and obligations. The IRS also charges interest on unpaid penalties.
Relief from IRS Penalties
Relief from penalties depends on the rules around each penalty. For the failure to file and pay penalties, relief us usually through an IRS administrative waiver such as First-time penalty abatement (FTA) or another announced waiver. For example, the IRS provided two administrative waivers related to COVID-19 pandemic for the failure to file and for the failure to pay penalties. Taxpayers can also request a waiver of the failure to file and pay penalties due to reasonable cause. Reasonable cause requires the taxpayer to show that there was circumstances outside of their control that caused noncompliance (i.e., filing or paying late) and that the taxpayer acted with ordinary care and good faith. Reasonable cause arguments are applied for in writing by taxpayers using IRS Form 843, Claim for Refund. The IRS reviews each Form 843 and makes an initial determination on the request for abatement. It is normal for the IRS to deny penalty relief. However, taxpayers can request an appeal to have an IRS Appeals Officer to take a second look at the request.
Relief from the estimated tax penalties is requested when the taxpayer files a return and asks for an exception to the estimated tax penalty. Individual taxpayers use IRS Form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts.
Taxpayers can contest an accuracy penalty during an audit or a CP2000 notice by replying to the IRS auditor, in writing. The taxpayer must show how they made a reasonable attempt to comply. The IRS will make a determination and the taxpayer can appeal any adverse determination. If the taxpayer has already been assessed an accuracy penalty, they must request reconsideration of the audit or CP2000 notice determination to have it removed.
