What Penalties Does the IRS Impose? What Are These Penalties For?

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Did you forget to file your business taxes on time? Or did you pay less than the required amount? You or your business may be subject to IRS penalties and fines. You must pay penalties for underpayment and for late payment, and you will have to pay fines and interest on the money due.

The most important thing to remember about IRS penalties and fines is that they stop adding up when you pay in full. So, the best way to keep these costs to a minimum is to pay as much as possible as soon as possible.

The IRS says,

"If you do not file your return and pay your tax by the due date, you may have to pay a penalty. You may also have to pay a penalty if you substantially understate your tax, understate a reportable transaction, file an erroneous claim for refund or credit, or file a frivolous tax submission. If you provide fraudulent information on your return, you may have to pay a civil fraud penalty."

Tax Penalties and Small Businesses

Most small businesses are pass-through entities, because their business tax is included with their personal tax return. Corporations pay their business tax separately from the tax of their owners. So, if you are a small business owner, you will pay IRS penalties and fines based on the amount you underpaid or paid late, based on your total personal tax.

Here are the most common penalties for personal tax returns, which include Schedule C for sole proprietors and single-member LLCs, partnership returns, and S corporation returns:

Penalties for Late Filing/Late Payment

  • Failure to file by tax due date: 5 percent for each month or part of a month that the return is late, but not more than 25 percent. If you file more than 60 days after the due date, the minimum penalty is $135 or 100 percent of the tax on the return, if the return is filed more than 60 days after the due date.
  • Late payment: 0.5 percent of unpaid taxes for each month, or part of a month after the due tax. If you filed for an automatic extension, no penalties are applied if you paid at least 90 percent of your actual tax liability by the due date and the balance by the extension date.
  • The IRS also imposes combined penalties for filing and paying late.

Penalties for Late Filing of Business Tax Returns

Partnership Returns. The late filing penalty for a partnership return is $89 for each partner, for each month or part of a month (up to 12 months) the return is late (or does not contain the required information) multiplied by the total number of persons who were partners in the partnership during any part of the partnership's tax year. No penalty will be imposed if the partnership shows that the late filing was due to reasonable cause.

S Corporation ReturnsIf no tax is due, the late filing penalty for returns required to be filed through the 2009 tax year is $89 for each month or part of a month (up to 12 months) the return is late or does not include the required information, multiplied by the total number of persons who were shareholders in the corporation during any part of the corporation's tax year. The penalty change discussed in the preceding sentence also applies if more tax is due. In addition, the minimum additional late filing penalty for returns required to be filed after 2008 that are more than 60 days late increased to $135 or the balance of the tax due on the return, whichever is smaller. For more information, see the Instructions for Form 1120S.

Accuracy Related Penalties

The two most common accuracy-related penalties are the "substantial understatement" penalty and the "negligence or disregard of the rules or regulations" penalty. These penalties are calculated as a flat 20 percent of the net understatement of tax.

  • Penalty for substantial understatement
    If you understate your tax (show less than the correct tax) the penalty depends on whether the understatement is substantial or not. If the understatement is more than the larger of 10 percent of the correct tax or $5,000 for individuals, it is substantial. For corporations, the understatement is considered substantial if the tax shown on your return exceeds the lesser of 10 percent (or if greater, $10,000) or $10 million.
    You may be able to avoid the substantial understatement penalty if you properly disclose your authority for the tax treatment of the item/s in question or if you have a reasonable basis for your position. (Use Form 8275).
  • Penalty for negligence and disregard of the rules and regulations
    You may also incur penalties if you disregard IRS rules and regulations by not adequately substantiating a tax position or if there is no reasonable cause for your position. You will not have to pay a negligence penalty if there was a reasonable cause for a position you took and you acted in good faith.

Fraud and Frivolous Return Penalties

If your underpayment or late payment can be proved to be intentional, that's tax fraud, and it results in larger penalties. 

  • Fraud
    If there is any underpayment of tax on your return due to fraud, a penalty of 75 percent of the underpayment due to fraud will be added to your tax. Negligence or ignorance of the law does not constitute fraud.
  • Frivolous Return
    If you file a frivolous tax return, the IRS can impose a penalty of $5,000 on you (and a similar penalty on your spouse, if you file a joint return). The IRS says that a frivolous return is one that "does not include enough information to figure the correct tax or that contains information clearly showing that the tax you reported is substantially incorrect."

Penalty for Bounced Check

If the check you use to pay the IRS bounces, they can charge you a penalty. The penalty is 2 percent of the amount of the check, unless the check is under $1,250, in which case the penalty is the amount of the check or $25, whichever is less.

Penalty Relief From the IRS

Your business may qualify for penalty relief. See this article from the IRS on penalty relief for more information.