How Do Tax Penalties Work?


Cowardly or not, the Internal Revenue Service and state Taxing Authorities assess penalties against taxpayers who do not meet their tax obligations. Penalties are very costly, and are meant to be that way to discourage citizens from failing to timely file and/or pay the balances due on tax returns. If at all possible, it is always wise to avoid incurring tax penalties by filing and paying all returns when due, making timely and sufficient quarterly estimated tax payments where required, and making proper federal tax deposits if you have a business with employees.

However, if you are reading this, it may be too late to avoid penalties. You may be more concerned with how and why these penalties were assessed against you, and what you can do about it.

The major types of penalties assessed by the Internal Revenue Service against taxpayers are as follows:

  • Failure to File: The Internal Revenue Code imposes a penalty for failure to file a tax return by the due date of 5% of the amount due on the return, for each month or part of a month that the return is late, up to a maximum of 25% of the amount due.
  • Failure to Pay: The penalty for failure to pay is .5% of the unpaid amount, for each month or part of a month that the tax remains unpaid, up to a maximum of 25%. Ten days after notice and demand for payment, this amount is increased to 1%, and if an individual taxpayer enters into an Installment Agreement, this amount is reduced to .25% during the Installment Agreement.
  • Federal Tax Deposit Penalty: The penalty for failure to make a timely federal tax deposit of employer withholding tax begins at 2% of the tax due, and increases up to 15% depending on how late the deposit is made. To ensure compliance, employers should make a deposit in full for each payroll period no later than three business days after each payroll date.
  • Estimated Tax Penalty: Self employed individuals must make quarterly estimated tax payments. The penalty for failure to make these quarterly payments is the federal short-term rate plus 3%.
  • Trust Fund Recovery Penalty: This penalty may be assessed against any person who is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes, and willfully fails to collect or pay them. A responsible person for this purpose can be an officer of a corporation, a partner, a sole proprietor, or an employee of any form of business. A trustee or agent with authority over the funds of the business can also be held responsible for the penalty.

Taxpayers have the right to request removal of penalties, known as penalty abatement. Generally, a taxpayer should have the tax fully paid or be on a formal resolution such as an Installment Agreement before it is wise to request penalty abatement. The standard used by the Internal Revenue Service in deciding whether to abate penalties is “reasonable cause.” If a taxpayer can show that the failure to file and/or pay was due to reasonable cause and not willful neglect, the Internal Revenue Service will abate the penalties and the interest on those penalties. Penalty relief is also available for one period based on a clean compliance history for prior periods. If you were assessed the Trust Fund Recovery Penalty or have a proposed assessment pending, you may be able to remove or prevent this assessment if you were not willful and responsible.

Most states have similar penalty and abatement structures to the Internal Revenue Service rules listed above. Penalties are difficult to stomach. However, if penalties have been assessed against you, you can minimize the damage by remaining current on all tax obligations moving forward, establishing a formal resolution to the back tax liabilities, and requesting abatement of all assessed penalties. At 20/20 Tax Resolution, we specialize in guiding and representing you through this often-complicated process, while working to keep you protected from enforced collection by the Taxing Authorities.

“A penalty is a cowardly way to score.” –Pele