Owing back taxes to the IRS can be an unsettling time in a taxpayer’s life, and if that was not bad enough, the IRS often times charges penalties for these late and unpaid taxes.
The amount of the penalty will depend on a few factors. Lower dollar amounts will have a lesser penalty than higher dollar amounts, and willful infractions will have a larger penalty than innocent mistakes.
COVID-19 has made this year particularly difficult, and if you owe taxes to the IRS, you are probably looking for help and relief. Because of COVID-19, you may find some recourse regarding your IRS penalties. Below I will discuss these IRS penalties and how COVID-19 has changed these policies.
What are IRS Penalties?
The IRS views these taxes as their money, so it makes sense that they would penalize taxpayers who do not pay up. Additionally, the IRS says “penalties exist to encourage voluntary compliance by supporting the standards of behavior required by the Internal Revenue Code.”
To additionally justify these penalties, according to the IRS, “penalties encourage voluntary compliance by defining standards of compliant behavior, defining consequences for noncompliance, and providing monetary sanctions against taxpayers who do not meet the standard.” Now that we have gotten through the “why,” what about the “how?”
Common penalties include:
- failure to file,
- failure to pay,
- failure to pay proper estimated tax, and
- dishonored check.
Failure to file occurs when the taxpayer does not file their tax return by their due date or extended due date. Failure to pay is similar, but instead it is just the failure of the taxpayer to pay the taxes reported on their return.
The failure to pay the proper estimated tax penalty is when the taxpayer does not pay enough taxes. The dishonored checks penalty occurs when the taxpayer’s bank does not honor the taxpayer’s payment.
The failure to file penalty is calculated as 5% of the unpaid tax reduced by the “failure to pay” penalty amount for any month where both penalties apply. This penalty is charged each month the return is late, up to 5 months, and applies for a full month, even if the return is filed less than 30 days late.
Under Internal Revenue Code §6651, the failure to pay penalty can be divided up into two categories: failure to pay tax reported on return and failure to pay tax not reported.
For failure to pay tax reported on return, the penalty is 0.5% of tax not paid by due date, April 15; 0.25% if not paid during approved installment agreement; or 1% if tax is not paid within 10 days of a notice of intent to levy a penalty.
There is a recurring, additional penalty charge on the remaining unpaid tax each month until the tax is fully paid or until a penalty of 25% is reached.
However, for failure to pay tax not reported, and not paid within 21 days of the date of notice and demand, there is a penalty of 0.5% of tax not paid; 0.25% if not paid during approved installment agreement; or 1% if tax is not paid within 10 days of a notice of intent to levy a penalty. The penalty is a recurring charge on the remaining unpaid tax each month until the tax is fully paid.
Above we introduced the failure to pay the proper estimated tax penalty. That penalty is calculated on a case-by-case basis, and is largely determined by the number of days late multiplied by the effective interest rate for the installment period.
Not everyone makes estimated tax payments, but they are generally required if the taxpayer expects to owe $1,000 or more. For more information, visit the IRS’s publication on “Tax Withholding and Estimated Tax.”
Finally, for dishonored check or other form of payment penalties, the penalty for payments of $1,250 or more is 2% of the amount of the payment, and for payments less than $1,250, the penalty is the amount of the payment or $25, whichever is less.
However, certain taxpayers may qualify for penalty relief.
Taxpayers “may qualify for relief from penalties if [they] made an effort to comply with the requirements of the law, but were unable to meet [their] tax obligations, due to circumstances beyond [their] control.” The penalties that are eligible for relief are: failing to file a tax return, failing to pay on time, failing to deposit certain taxes as required, and other penalties as applicable.
The types of penalty relief offered by the IRS are reasonable cause, administrative waiver and first time penalty abatement, and statutory exception. However, it is important to know that interest relief is unavailable and interest will continue to accrue.
Typical situations establishing reasonable cause are:
- Fire, casualty, natural disaster or other disturbances
- Inability to obtain records
- Death, serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family
- Other reason which establishes that you used all ordinary business care and prudence to meet your Federal tax obligations but were nevertheless unable to do so
Lack of funds is not a reasonable cause. However, due to COVID-19, many people have called upon the IRS to increase penalty relief. Below I will discuss how coronavirus has impacted these penalty programs.
Further COVID-19 Taxpayer Relief?
In December 2020, the IRS was urged, again, to provide penalty relief amid the pandemic. The IRS was called on by a coalition led by the American Institute of CPAs (AICPA) to offer penalty relief to Americans facing hardship due to COVID-19.
The AICPA cites “many examples of returns being unavoidably filed late due to a death or illness with the client, employees within the client’s business, or even with the tax practitioner themselves.” And the IRS’s response?
"The IRS will not give penalty relief 'carte blanche' to taxpayers who miss deadlines during the coronavirus pandemic." Instead of implement the streamlined and expedited reasonable cause penalty abatement process that eliminates the need for written requests that the AICPA called for, Charles Rettig, the Commissioner of the IRS, "urged individuals who are facing penalties as a result of pandemic-related issues to bring those issues to the attention of IRS employees.”
Rettig would go on to say that he expects people to find the IRS quite open and accepting in terms of any types of penalties that might come. Additionally, Rettig “noted that the agency is training employees to be more sympathetic to the unique challenges taxpayers are facing at this time.”
While the IRS’s refusal to implement new penalty abatement relief may not be ideal for taxpayers who owe money to the IRS, the words of the Commissioner may give taxpayers some hope.
The IRS’s People First Initiative has expired after it was implemented for the first few months of the pandemic. However, the IRS has stated that it will be offering more relief with three main goals:
- Immediate, broad-based relief from unpaid liabilities resulting from COVID-19
- Removal of bureaucratic barriers and expansion of flexibilities to all taxpayers whose financial condition has been affected by COVID-19
- Balance the relief provided against the need to uphold the nation’s tax laws
The IRS wants to make it clear that people who have questions about paying their taxes should contact the IRS. The IRS goes on to say, “when appropriate, we want to help taxpayers by taking steps like abating penalties, extending payment plans, expanding access to installment agreements, and providing relief for taxpayers having difficulty meeting the terms of previously accepted offers to settle tax debts.”
In addition to first-time penalty abatement for reasonable cause, the words of the IRS may be cause for hope for taxpayers who are looking for relief.
Owing money and penalties to the IRS is not fun, but you do not have to go through it alone. If you are a taxpayer who is looking for penalty relief due to COVID-19 or some other reasonable cause, contact our office and we will help guide you through the process of dealing with the IRS. For more information, visit our website.