- Learn about the penalty for underpayment of estimated tax and withholding.
- Find out how to prevent the required minimum distribution penalty.
- Learn details about the late-filing penalty.
- Find out why you should avoid the late-payment penalty.
- Discover the hefty penalty for negligence.
- Find out which penalty is one of the most costly.
- Learn how to avoid the dishonored check penalty.
- Discover the penalty for failing to provide a Social Security Number.
- Learn about the early withdrawal penalty regarding qualified retirement plans.
- Remember to report your tips or pay the penalty!
- Learn about foreign reporting penalties.
- Discover the ways one can avoid the excessive claim penalty.
- Find out more about the accuracy-related penalty for non-itemizers regarding charitable contributions.
- Learn about the frivolous return penalty.
- Discover the penalty for failure to file information returns.
Have you ever been hit with a tax penalty? Most taxpayers don’t intentionally incur tax penalties. Many who are penalized are simply unaware of the penalties or the possible damage they can do to their wallets. As tax season approaches, Fiducial looks at some of the more commonly encountered penalties and how they may be avoided.
Underpayment of Estimated Taxes and Withholding Penalty
The United States’ income tax system is a pay-as-you-earn tax system. This means that taxpayers must pay their tax liability as they receive income during the year through withholding or by making estimated tax payments. Normally, taxpayers make estimated tax payments in four installments. Installments are due by April 15, June 15, September 15, and January 15 of the subsequent year.
If a taxpayer owes more than $1,000 when filing their return for the year, the IRS will assess the penalty for underpayment of estimated tax. This is currently 3% of the underpayment. “Safe harbor” payments can protect you from this penalty, which are payments of 90% of the current year’s tax liability or 100% (110% for high-income taxpayers) of the prior year’s tax liability. Farmers and fishermen need only prepay 66-2/3% of their current liability or 100% of their prior year’s liability.
The 100%/110% safe harbor works well when the taxpayer’s tax will be higher than that of the prior year. But when a taxpayer anticipates a large drop in income as compared to the prior year, there can be a huge impact on the necessity of estimated tax payments.
The 100% and 110% of the prior year’s tax liability are most likely not viable safe harbor amounts for estimated tax in the lower-income year. Most taxpayers will want to pay 90% of the current year’s tax liability. Contact your Fiducial representative to see if you need to make any payments and, if so, how much.
Required Minimum Distribution (RMD) Penalty
To prevent an individual from investing in tax-deferred retirement plans, including traditional IRAs, but never withdrawing funds from the plans (which would mean the government wouldn’t ever collect taxes on the retirement funds), retirees must take an RMD each year after reaching the mandatory RMD age. The mandatory distribution age is currently 72.
Failing to take the correct minimum distribution (also known as excess accumulation) results in a penalty of 50% of the difference between what should have been withdrawn and what was actually withdrawn. However, the IRS generally is very liberal about abating the penalty in most situations when taxpayers take corrective action.
Late-Filing Tax Penalty
If taxpayers file their return after the due date, including after extensions, the IRS applies a late-filing penalty of 4.5% per month (maximum 22.5%). The normal due date for returns is April 15 of the subsequent year. Because of COVID-19, the IRS extended the original due date for 2020 returns to May 17, 2021.
Those who had not filed by that date could have requested a further extension to October 15, 2021. If you have not filed your 2019, 2020, or any earlier year’s return, you should do so as soon as possible. This will minimize your late-filing penalties.
If a return is over 60 days late, the minimum penalty for failure to file is the lesser of $435 ($450 in 2022) or 100% of the tax shown on the return. The obvious way to avoid a late-filing penalty is to file in a timely fashion. However, the IRS will consider abating the penalty if you can prove there was reasonable cause and no willful neglect.
Late-Paying Tax Penalty
If taxpayers pay the tax owed on a return after the unextended due date of the tax return (usually April 15 but is May 17 for 2020 returns filed in 2021), then the taxpayer will be subjected to a penalty of 1/2% per month (maximum 25%) of the unpaid balance. Taxpayers are frequently caught by this penalty when they need an extension to file their tax return; many fail to realize that the extension does not include an extension on paying.
How do taxpayers avoid or minimize this penalty? They must have no or little balance due on the return when they finally file. The extension form includes a provision to pay the projected balance owed when filing the extension
Negligence
When underpayment is due to taxpayer negligence or when there are errors in tax valuations, a penalty of 20% of the tax underpayment will be charged. Taxpayers frequently encounter this penalty when the IRS adjusts a filed return due to unreported income or overstated deductions.
Fraud
The fraud penalty is 75% of the tax unpaid due to fraud.
Dishonored Check
The penalty for dishonored checks of over $1,250 is 2% of the check amount. If the amount is $1,250 or less, the penalty is the amount of the check or $25, whichever is less. What should you do if you don’t have sufficient funds to pay your tax when you file your return? Rather than writing a check that you know will bounce, you may be able to arrange an installment payment plan with the IRS. You may still incur late-payment charges, but the penalty rate will be lower if you are on a payment plan.
Missing ID Number
A $50 penalty for each missing number applies when a taxpayer doesn’t provide a required Social Security number (SSN) for themselves, a dependent, or another person on their tax return. It is also charged when the taxpayer doesn’t provide their SSN to another person or entity when required.
Early Withdrawal Tax Penalty
If a taxpayer is under age 59½ and withdraws assets (money or other property) from a qualified retirement plan, including traditional IRAs, the taxpayer must pay a 10% additional tax, commonly referred to as the early withdrawal penalty. This tax is 10% of the part of the distribution that the taxpayer was required to include in their gross income for the year of the distribution. A number of exceptions apply to this penalty.
As part of COVID-19 relief, this penalty was waived on distributions of up to $100,000 from qualified retirement plans and traditional IRAs during 2020. Early withdrawals in 2021 and later years are subject to the penalty unless one of the several exceptions applies.
Failure to Report Tips
If a taxpayer didn’t report tips to their employer, they will have to pay a penalty. It equals 50% of the Social Security tax on the unreported tips.
Reporting Foreign Accounts and Assets
There are numerous and substantial penalties for failures to report a variety of foreign accounts and assets. Some of the penalties are even draconian. Contact your Fiducial representative if you have a foreign financial account, foreign trusts, ownership in a foreign corporation, received foreign gifts, and so on.
Excessive Claim Tax Penalty
If a taxpayer makes a claim for a refund or credit for income tax for an excessive amount, the person making the claim is liable for a penalty equal to 20% of the excessive amount. The excessive amount is the amount by which one’s claim for any tax year exceeds the amount of the claim allowable for that tax year.
The penalty doesn’t apply if taxpayers can show that they made the claim for the excessive amount with reasonable cause. The penalty also does not apply if any portion of the excessive amount or credit is subject to an accuracy-related penalty.
Accuracy-Related Tax Penalty for Non-Itemizers
For 2021, taxpayers may take a deduction of up to $300 ($600 on married joint returns) for cash contributions to qualified charitable organizations. Usually, only individuals who itemize their deductions can deduct donations to charities. As part of the accuracy-related penalty, a non-itemizing taxpayer who overstates their charitable donation may have to pay a penalty. The penalty consists of 50% of the tax attributable to the overstatement, rather than the normal 20% penalty.
Frivolous Return
In addition to any other penalties, the law imposes a $5,000 penalty for filing a frivolous return. A frivolous return does not contain information needed to establish the correct tax or shows a substantially incorrect tax because the taxpayer takes a frivolous position or displays a desire to delay or interfere with the tax laws. This includes altering or striking out the preprinted language above the space where the taxpayer signs. Under limited circumstances, the IRS may reduce the penalty from $5,000 to $500.
Failure to File Information Returns
A taxpayer who, without reasonable cause, fails to file a required information return in the manner the law specifies or by the proper deadline, fails to include all of the information required, or includes incorrect information will be subjected to a penalty of $280 for each return required to be filed during 2021 or 2022. The penalty will be reduced to $50 if the failure is corrected within 30 days of the due date and $110 if corrected by August 1.
Have any of these penalties has been assessed against you? Want to know if any of them can be reduced or removed? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.
Ready to book an appointment now? Click here. Know someone who might need our services? We love referrals!
For more small business COVID-19 resources, visit Fiducial’s Coronavirus Update Center to find information on SBA loans, tax updates, the Paycheck Protection Program, paid sick and family leave.