Sam Brotman, JD, LLM, MBA October 7, 2020 19 min read

IRS Penalties

Total failure to file a tax return and pay all balances owed will result in the IRS charging an IRS penalty, which is usually “five percent of the tax owed for each month, or part of a month that your return is late, up to five months. If your return is over 60 days late, the minimum for late filing is the lesser of $135 or 100 percent of the tax owed” (“Topic 653”). 

According to the Internal Revenue Manual’s Penalty Handbook[1], the purpose of penalties, or the assessment thereof, is to encourage voluntary compliance by defining standards specific to compliant behavior, defining consequences for noncompliance, and providing monetary sanctions against taxpayers failing to meet the standard (IRM, “20.1.1.2 Purpose of Penalties,” 8/13/2013). 

In addition, according to the Internal Revenue Manual, relief from IRS penalties falls under four categories, which include the following: 1) reasonable cause, 2) statutory exceptions, 3) administrative waivers, and 4) Correction of Service error (IRS.gov, “20.1.1.3 Criteria for Relief From Penalties,” 8/14/2013).

An appeal may recommend abatement or non-assertion. When determining an IRS penalty, the IRS generally considers requests from third parties, “including requests from representatives without an authorized power of attorney. 

While information may be accepted, no taxpayer information may be discussed with a third party unless a valid power of attorney ... is secured in writing from the taxpayer” (“Criteria for Relief From Penalties”). Organization of the Penalty Handbook is subject to Part 20. Penalty and Interest of the Internal Revenue Manual. 

Below is a brief outline of the handbook. To view it in its entirety, visit: 20.1.1.1.2, Organization of IRM 20.1, Penalty Handbook here: >https://www.irs.gov/irm/part20/irm_20-001-001r 

Sections of the IRM 20.1 include the following:

  • Introduction and Penalty Relief
  • Failure to File/Failure to Pay Penalties
  • Estimated Tax Penalties (ES)
  • Failure to Deposit Penalty (FTD)
  • Return Related Penalties
  • Preparer, Promoter, Material Advisor Penalties
  • Information Return Penalties
  • Employee Plans and Exempt Organizations
  • Miscellaneous Civil Penalties
  • International Penalties
  • Miscellaneous Penalties
  • Excise Tax and Estate and Gift Tax Penalties
  • Penalties Applicable to Incorrect Appraisals

There are different types of IRS penalties. The following sections outline those types of penalties for which the IRS charges. Below is an overview of the penalties. You may visit the IRS website or review information housed within the Internal Revenue Manual for more insight into the different types of penalties.

Types of IRS Penalties

Underestimate and Late Payment IRS Penalties

It is possible for a taxpayer to underestimate the amount of tax due, because estimations are based upon predictions. A taxpayer is required to withhold tax or make quarterly estimated tax payments by the end of the year and must estimate this amount. 

There is an IRS penalty assessed for amounts that are too little than estimated or have too little tax withheld. The penalty is computed similarly to interest on the amount that should have been paid but not paid.

A different charge applies for a taxpayer who has filed an income (or excise) tax return and incurs a balance but fails to pay that balance when due (without extensions). The charge within this context has two parts. 

The first part is an interest charge. It is computed in the same way as the penalty charge above. The second charge is a penalty of 0.5 percent per month. The second charge is applied to the unpaid balance of both tax and interest. The 0.5 percent per month charge is capped at 25 percent of the total unpaid tax. 

“The underestimate penalty and interest on late payments are automatically assessed. No ‘reasonable cause’ exception is available for avoiding these penalties” (Wikipedia.org, “IRS Penalties,” 9/11/2013). Taxpayers can expect to be charged these penalties regardless of their financial and/or economic situation.

IRS Penalties for Failure to Timely File Tax Return

There are three categories that fall under this section of IRS penalties. For one, the penalty for failure to timely file return is defined as the failure of the taxpayer to file an income or excise tax return in a timely manner. 

Within this context, the taxpayer’s tax balance will be assessed a late filing penalty. The penalty assessed is 5 percent of the amount of unpaid tax per month the return is late, up to a maximum of 25 percent. A minimum penalty of $135 may apply for late filing of an income tax return” (Wikipedia.org, “IRS Penalties,” 9/11/2013). 

In contrast, the penalty for failure to timely pay tax is defined as the taxpayer’s failure to pay the amount shown on a tax return. Bounced checks apply. The penalty assessed for this type of failure is 0.5 percent “of the amount of unpaid tax per month the return is late up to a maximum of [25 percent]” (Wikipedia.org, “IRS Penalties,” 9/11/2013).

The third category is IRS penalty for failure to timely pay after issuance of notice. This IRS penalty is assessed because of the taxpayer’s failure to pay the tax or other related required amount shown on the tax return, but it is not shown on the return. In this case, the taxpayer will be liable for a penalty of 0.5 percent per month applied to the amount.

The penalty is applied each month the failure continues. The penalty is applied also “if the amount is not paid within 21 calendar days after the date of an IRS notice demanding the payment” (Wikipedia.org, “IRS Penalties,” 9/11/2013). In cases where the penalty for failure to file and the penalty for failure to pay is assessed at the same time, “then the failure to file penalty is reduced by 0.5 percent each month” (Wikipedia.org, “IRS Penalties,” 9/11/2013). 

The 25 percent cap will only apply to the 5 percent late filing penalty fee and the 0.5 percent late payment penalty (Wikipedia.org, “IRS Penalties,” 9/11/2013). In some cases, the late filing penalty can be waived or abated if the taxpayer can prove reasonable cause. 

The penalty for failure to file accrues interest from the date the return is due “whereas the failure to pay and failure to show penalties begin accruing interest from the date of notice and demand” (Wikipedia.org, “IRS Penalties,” 9/11/2013).

Accuracy Related Penalties

The IRS may assess an additional penalty for an amount reported on a taxpayer’s income tax return that is later adjusted but results in a tax increase. “This penalty of 20 percent or 40 percent of the increase in tax is due in the case of substantial understatement of tax, substantial valuation misstatements, transfer pricing adjustments, or negligence or disregard of rules or regulations” (Wikipedia.org, “IRS Penalties,” 9/11/2013). Special rules are considered for each type of error where a penalty is applicable.

Penalties and Information Returns

An information return does not require payment of tax. An information return is defined as a type of tax form filed by employers and businesses to report wages and payments, respectively. 

For example, an employer may file a Form W-2 while a business may file one or more reports using Form 1099. “The penalty for failures related to these forms is a dollar amount per form not timely filed, and the amount of penalty increases with the degree of lateness” (Wikipedia.org, “IRS Penalties,” 9/11/2013). 

The maximum penalty for filing a late information return is $50. Many of the information returns are filed electronically. Additional penalties for failure to file a partnership income form (Form 1065, $195 per month per partner up to 12 months maximum) apply; and for failure to file an S Corporation return (Form 1120S).

Penalties Unpaid Withholding Taxes

Employers are required to withhold both income and Social Security taxes from employee wages. The amounts are then submitted and paid to the government. The employer will incur a “penalty of 100% of the amount not paid over (plus liability for paying the withheld amounts may be collected without judicial proceedings from each and every person who had custody and control of the funds and did not make the payment to the government” (Wikipedia.org, “IRS Penalties,” 9/11/2013). This rule applies to company employees, officers, individuals, and to companies themselves.

Penalties and Failure to Provide Foreign Information

Taxpayers who own shares in a controlled foreign corporation are required to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.

This form must be filed for each controlled foreign corporation. 

The penalty for failure to file on time ranges from $10,000 to $50,000 per form. The taxpayer may also lose foreign tax credits. “U.S. corporations more than 25 percent owned, directly or indirectly, by foreign persons must file Form 5472 to report such ownership and all transactions with related parties” (Wikipedia.org, “IRS Penalties,” 9/11/2013).

The use of Form 5472, Information Return of a 25 Percent Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business is required under sections 6038A and 6038C. The penalty for failure to file Form 5472 is $10,000 per required form. 

The penalty may be increased by $10,000 per month for continued failure (Wikipedia.org, “IRS Penalties,” 9/11/2013). Penalties may also be assessed for a taxpayer’s failure to report changes in those foreign taxes used as credits.

Additional penalty restrictions apply for both U.S. citizen and resident taxpayers (including entities) “who are beneficiaries of a foreign trust or make transfers of property to a foreign trust” (Wikipedia.org, “IRS Penalties,” 9/11/2013). Beneficiaries must report information about the transfer. Failure to file Form 3520[1] or Form 3520-A[2] will result in assessed penalties of up to 35 percent. 

A transferor to a foreign corporation must file Form 926, Filing Requirement for U.S. Transferors of Property to a Foreign Corporation. A penalty of 10 percent is typically assessed when the value of the transfer is up to $100,000. 

Lastly, a penalty of $500,000 plus jail is assessed for “failure to file Treasury Department Form TD F 90-22.1[3] each year by owners of or signatories to foreign bank or securities accounts” (Wikipedia.org, “IRS Penalties,” 9/11/2013).

Penalties and Excise Taxes

Federal excise taxes are typically imposed on goods and services. Taxes under this category may require a purchase of tax stamps or evidence of advanced payment of tax. Retailers may be required to collect the tax. Whether the entity is required to purchase tax stamps or collect the tax, the manufacturers’ and retailers’ goods and services are subject to an assortment of penalties. 

In addition, there are penalties that apply that are in the form of an excise tax. “Excise taxes are taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. 

There are also excise taxes on activities, such as on wagering or on highway usage by trucks” (IRS.gov, “Excise Tax,” 9/11/2013). Charities and private foundations are responsible for paying excise taxes. Lastly, penalties in the form of excise taxes may be assessed against pension and benefit plans.

[1] Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts

[2] Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner (Under Section 6048(b)

[3] Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (http://www.treasury.gov/services/Pages/TD-F-90-22.1-Report-of-Foreign-Bank-and-Financial-Accounts.aspx).

Tax Fraud Penalties

The IRS considers the filing of a false tax return to be fraud, which is a criminal offense. Taxpayers convicted of fraud or aiding another taxpayer in committing tax fraud will be “subject to forfeiture of property and/or jail time” (Wikipedia.org, “IRS Penalties,” 9/11/2013). 

Taxpayers are convicted and sentenced through the court system and it is the Department of Justice that prosecutes cases within this context. The IRS does not prosecute tax fraud cases. Once convicted, the taxpayer may incur tax fraud penalties based upon the type of tax case.

In other respects, tax protesters frequently argue that the current income tax laws are not valid. In response to this argument, they tend to file frivolous terms as well as frivolous court petitions. 

The IRS assesses a civil penalty for frivolous tax submissions.[1] A person who files a frivolous return based upon the policy presented in Part 4. Examining Process, Chapter 10. Examination of Returns, Section 12. Frivolous Return Program of the Internal Revenue Manual can expect to pay a penalty of $5,000. 

However, the Secretary provides for the person to withdraw his or her submission. If the taxpayer responds to the Secretary’s notice of a specified frivolous submission by withdrawing it within 30 days, “after such notice, the penalty imposed . . . shall not apply with respect to such submission” (Law.Cornell.edu, “26 USC – Frivolous tax submissions,” 9/12/2013). In essence, taxpayers that subsequently withdraw their frivolous tax submission will not incur a penalty.

Tax Adviser Penalties

Tax adviser penalties are the last types of penalties on this list. If a tax adviser promotes tax shelters, he or she can expect to incur a penalty. In addition, tax advisers who “fail to maintain and disclose lists of reportable transactions of their customers or clients for those transactions” will be responsible for paying a penalty. The penalty assessed is based upon the type of case and location — whether domestic or foreign.

Taxpayer and tax adviser penalties may be eligible for a first-time abatement depending upon the case.

[1] 26 USC 6702 – Frivolous Tax Submissions

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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