Federal Taxpayer Penalty Guide

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Common penalties and obtaining penalty abatement from the IRS.

The IRS can assess many types of penalties against taxpayers: late-filing penalties, late-payment penalties, estimated tax penalties, accuracy-related penalties, and the list goes on. This practice guide summarizes common IRS penalties that tax practitioners encounter on almost a daily basis and suggests procedural and practical tips that may lead to penalty relief.

Although penalty relief is not guaranteed, remember that those who do not ask will not receive it. Large, and sometimes even small, penalties are often worth fighting to get removed. A phone call or letter may be all that is necessary to save a client thousands of dollars. And do not be afraid to turn to the Independent Office of Appeals if your request is denied. It is common for penalty cases to be resolved through an appeal.

In this guide, you’ll find information about penalties related to:

Contact us if you need help with any of these IRS-related penalties.


Accuracy

How is it calculated or assessed?

In general, the penalty is assessed at a flat 20% on the portion of an underpayment of tax attributable to negligence, a substantial understatement of income tax, a substantial valuation misstatement, a substantial overstatement of pension liabilities or a substantial estate or gift tax valuation understatement. In certain situations, the penalty is increased.

Criteria for Abatement:

  • Reasonable cause.

There is no first-time penalty abatement relief for accuracy-related penalties.

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Estimated Tax

How is it calculated or assessed? The penalty is the same as the interest rate for underpayments of tax, which the IRS announces quarterly in accordance with Sec. 6621, Determination of rate of interest. Most tax preparation software calculates this penalty on IRS Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, and Form 2220, Underpayment of Estimated Tax by Corporations. See the instructions for these forms. If the penalty is not paid with the return, the IRS will send a notice.

Criteria for Abatement:

  • IRS error
  • Calculating the penalty under a different method reduces or eliminates it
  • Limited waiver criteria
  • Eligible for safe harbor
  • Reasonable cause if retired after reaching age 62 in 2017 or 2018

It is advisable to request transcripts from the IRS each year to determine how payments/refunds are applied. Its possible penalties may be reduced or eliminated by applying payments to different tax periods. Check out the IRS’s Tax Withholding Estimator.

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Failure to File

Failure to file an individual, estate, gift, trust or C corporation return(Forms 1040, 1041, 706, 709 and 1120)

How is it calculated or assessed? The penalty is 5% of the tax due on the return, accruing each month or partial month that the return is late. It continues to accrue for up to five months, to a maximum of 25% of the amount owed. If the failure-to-file and failure-to-pay penalties run simultaneously, the failure-to-file penalty is imposed at 4.5% and caps out at 22.5%. If the failure to file is fraudulent, the penalty is 15% of the tax due per month, up to a maximum of 75% of the amount owed. A minimum failure-to-file penalty can apply.

Criteria for Abatement:

  • First-time penalty abatement (N/A Form 706/709) and other administrative waivers
  • Reasonable cause

The first-time penalty abatement waiver is an administrative waiver that the IRS may grant to relieve taxpayers from failure-to-file, failure-to-pay, and failure-to-deposit penalties if certain criteria are met. The policy behind this procedure is to reward taxpayers for having a clean compliance history; everyone is entitled to one mistake.

Failure to file an S corporation return (Form 1120S)

How is it calculated or assessed? The penalty equals $195 (indexed for inflation) multiplied by the number of shareholders in the S corporation at any time during the tax year. For a return with no tax due, the penalty is

assessed for each month or partial month that the return is late or incomplete, up to a maximum of 12 months. If tax is due, an additional penalty is assessed equal to 5% of the unpaid tax for each month or partial month that the return is late, up to a maximum of 25% of the unpaid tax. A minimum failure-to-file penalty can apply.

Criteria for Abatement:

  • First-time penalty abatement and other administrative waivers
  • Reasonable cause

Failure to file a partnership return (Form 1065)

How is it calculated or assessed? The penalty equals $195 (indexed for inflation), multiplied by the number of partners in the partnership during any part of the tax year. The penalty is assessed for each month or partial month for which the return is late or incomplete, up to 12 months. The penalty is assessed against the partnership.

Criteria for Abatement:

  • First-time penalty abatement and other administrative waivers
  • Reasonable cause

Failure to file a not-for-profit return (Form 990)

How is it calculated or assessed? For organizations with gross receipts less than $1 million (indexed for inflation), the penalty is $20 for each day during which the failure continues, with a maximum penalty of the lesser of $10,000 or 5% of the organization’s gross receipts for the year. If gross receipts are more than $1 million (indexed for inflation), the penalty is $100 for each day the return is late with a maximum penalty of $50,000 (indexed for inflation).

Criteria for Abatement:

  • Administrative waivers
  • Reasonable cause

When requesting penalty abatement, always indicate that the organization took corrective measures as soon as the mistake was brought to its attention; state that the organization. See exempt organizations abatement of late-filing penalties and other guidance (irs.gov).

Failure to file international information returns (Forms 5471, 5472, 8858, 8865, 926 and 8938)

How is it calculated or assessed? Form 5471, 8858 or 8865: The IRS may assert a $10,000 penalty for each failure for each applicable annual accounting period, plus an additional $10,000 for each month the failure continues, beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $60,000 (Sec. 6038(b)). Also, foreign taxes used to compute the foreign tax credit may be reduced (Sec. 6038(c)).

Form 5472: The IRS may assert a $25,000 penalty for each failure for each applicable tax year, plus an additional $25,000 for each month the failure continues, beginning 90 days after the taxpayer is notified of the delinquency; the statute does not provide a maximum penalty (Sec. 6038A(d)).

Form 8865 (Schedule O) and Form 926: The IRS may assert a penalty of 10% of the property’s fair market value at the time of transfer (limited to $100,000).

Form 8938: See Form 5471 et al., above(Sec. 6038D(d).

Criteria for Abatement:

  • First-time penalty abatement (special cases)
  • Reasonable cause

The statute of limitations under Sec. 6501(c)(8) is open indefinitely until Forms 5471/5472 are filed.

Failure to file a Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114)

How is it calculated or assessed? A penalty, not to exceed $10,000, may be imposed on any person who violates or causes any violation of the FBAR filing and recordkeeping requirements. Persons who willfully fail to report an account may be subject to a penalty equal to the greater of $100,000 or 50% of the balance in the account at the time of the violation, for each violation. Willful violations may also be subject to criminal penalties including additional monetary penalties and/or imprisonment.

Criteria for Abatement:

  • Reasonable cause

See Options available for U.S. taxpayers withundisclosed foreign financial assets (irs.gov).

Failure to file an annual return to report transactions with foreign trusts and receipt of certain foreign gifts (Forms 3520 and 3520-A)

How is it calculated or assessed?

Form 3520: Greater of $10,000 or the following (as applicable):

  • 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust
  • 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution
  • 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (Sec. 671 through 679) for failure by the U.S. person to report the U.S. owner information

Form 3520-A: Greater of $10,000 or the 5% penalty (discussed above)

Form 3520 (gifts only): 5% of the fair market value of the gift per month up to 25%

Additional civil and criminal penalties may apply.

Criteria for Abatement:

  • Reasonable cause

See Options available for U.S. taxpayers withundisclosed foreign financial assets (irs.gov).

Failure to file or furnish a correct payee statement (Schedules K-1, Forms 1099, 1042-S, W-2, etc.)

How is it calculated or assessed? A $250 penalty may be imposed for each failure. A maximum penalty is $3 million for all such failures during a calendar year (indexed for inflation). If the requirement to report information is intentionally disregarded, the penalty is increased to $500 (indexed for inflation) or, if greater, 10% of the aggregate amount of items to be reported (no maximum applies).

Criteria for Abatement:

  • Reasonable cause
  • Inconsequential error
  • Exception for de minimis failures

An inconsequential error or omission is not considered a failure to comply with a specified information reporting requirement (no penalty will be assessed).

The term “inconsequential” means any failure that does not make it difficult for the IRS to put the information to its intended use or prevent a payee from timely receiving correct information and reporting it on their return. An inconsequential error is not considered a failure to file. A missing taxpayer identification number is never inconsequential.

De minimis errors: If no single amount in error differs from the correct amount by more than $100, and no single amount reported for tax withheld differs from the correct amount by more than $25, then no correction shall be required (applies to payee statements required to be provided after Dec. 31, 2016).
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Failure to Pay

(Forms 1040, 1041, 706, 709 and 1120)

How is it calculated or assessed? The penalty equals 0.5% of the tax due and accrues each month or partial month that there is a balance due until reaching the maximum amount of 25% of the unpaid tax. If the taxpayer doesn’t pay the unpaid tax and receives a notice of intent to levy, the penalty increases to 1% per month or partial month. If the taxpayer establishes an installment agreement, the penalty decreases to 0.25%.

Criteria for Abatement:

  • First-time penalty abatement (N/A Form 706/709) and other administrative waivers
  • Reasonable cause

If a client establishes an installment agreement and meets the abatement criteria, request penalty abatement at the beginning of the agreement and again at the end. If the IRS removes penalties at the beginning of the agreement, and the taxpayer adheres to the terms of the agreement, the IRS can also remove the penalties that continued to accrue until the tax was paid in full.
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Payroll

Failure to deposit (Form 941)

How is it calculated or assessed? Multiply the payroll liability by:

  • 2% for deposits made 1–5 days late
  • 5% for deposits made 6–15 days late
  • 10% for deposits made 16 or more days late (or not made within 10 days of the date the first notice the IRS sent asking for payment)
  • 15% for amounts still unpaid more than 10 days after the date of the first notice the IRS sent asking for payment

Criteria for Abatement:

  • First-time penalty abatement and other administrative waivers
  • Reasonable cause

The IRS allows taxpayers to designate deposits or change prior designations to period(s). At times, this can be beneficial because penalties could be reduced or eliminated when deposits are applied differently. Note that a taxpayer must designate each deposit to a tax period within 90 days of receiving a failure-to-deposit penalty notice (Sec. 6656(e)(2)).

Trust fund recovery penalty (TFRP)

How is it calculated or assessed? This penalty may apply if certain excise, income, Social Security and Medicare taxes that must be collected or withheld aren’t collected or withheld, or these taxes aren’t paid. The penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for or paying over taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. The penalty is asserted by a revenue officer.

Criteria for Abatement:

  • Prove the taxpayer does not meet the requirements of a “responsible person.”
  • Prove the taxpayer did not willfully fail to perform the duties of collecting, accounting for or paying over trust fund taxes.

Sometimes an extension to the statute of limitations for assessment may be required. IRM 5.19.14.2.2, Trust fund recovery penalty statute of limitations, provides details on the statute of limitations for specific trust fund taxes.
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