Tax penalties can be daunting, but they don't have to be confusing. Here's how to minimize or avoid the most common penalties imposed by the IRS.
common tax penalties
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Things don't always go smoothly when it comes to filing tax returns on time and paying taxes. Even with the best of intentions, you could face a tax penalty from the IRS if you understate your quarterly payments, miss a tax return deadline, or bounce a check to the IRS.
Mistakes happen, but it helps to know the types of penalties the IRS calculates and how they are calculated. It's also a good idea to know your options if you've been penalized by the IRS.
common tax penalties
Here are four common tax penalties the IRS charges taxpayers and tips on how to avoid them.
This year, tax returns are due on April 18, 2023. If you need more time, you can apply for an extension, which gives you until October 15 to file your tax return. If you don't apply for an extension or miss the extended due date, the IRS will impose a penalty for not filing a penalty.
This tax penalty is 5% of unpaid tax for each month or part of a month that your tax return is late. However, it is limited to 25% (5 months) of your balance. If your return is more than 60 days late, a minimal penalty applies. The minimum fine is $435 or 100% of tax due, whichever is less, for tax returns due after 1/1/2020.
To avoid failing to file a fine, be sure to submit your statement by the due date (or extended due date), even if you are unable to pay the balance due. You have a little more leeway when waiting for a refund. In that case, the IRS will not impose a default penalty if you delay filing your tax return. However, you could lose your refund if you don't file your return within three years of the original due date.
lack of payment
Are you filing your tax return on time?request an extension, the IRS requires you to pay the tax due by the filing date. If you don't pay what you owe by that date, the IRS will apply a default penalty.
This tax penalty is 0.5% of taxes owed per month, but capped at 25% of taxes owed. When setting up an IRSInstallment Agreement, the IRS reduces the penalty for non-payment to 0.25% of the tax due while the installment plan is in effect.
Both non-submission of the fine and non-payment of the fine will be charged for a full month, even if you pay the balance due before the end of the month. If both penalties are for the same month, the default penalty is reduced by the amount of the default penalty, so the maximum combined penalty for default and non-payment is 5% for each month.
To avoid or at least minimize oversights, pay your taxes in full by the due date, even if you request an extension. If you owe more than you can pay, pay as much as you can on time and pay the rest as soon as you can. If you cannot pay off the remaining balance within a few months of the due date, you should apply for payment in installments.
Failure to pay the correct estimated tax
The IRS has a "pay as you go" system, which means that you must pay taxes throughout the year as you earn or receive income, rather than sending a large sum to the IRS at the end of the year.
If you owe more than $1,000 when calculating your taxes, you could face a penalty. To avoid this, make year-round payments with tax withheld from your paycheck orestimated quarterly payments, or both.
The IRS calculates this penalty by figuring out how much you should have paid each quarter and multiplying the difference between what you paid and what you should have paid by the effective interest rate for that period. This means that you can receive a penalty in one room, but not in the others.
To avoid or minimize estimated tax penalties,Adjust your tax deductionyour paycheck or estimate your tax bill and make estimated quarterly payments. These quarterly estimates are typically due on:
- April 15
- 15th of June
- January 15th
However, if one or more of these dates falls on a weekend or holiday, the deadline is moved to the next business day.
The IRS also offers two "safe harbor" methods for determining whether you are subject to a penalty. If you hit one of these safe harbor amounts, the IRS won't charge you an estimated tax penalty, even if you owe more than $1,000 at the end of the year.
The requirements are that you pay:
- 90% of taxes due in the current year. Estimate what you oweand pay at least 90% of this amount in four equal installments or deducting the paycheck.
- 100% (or 110%) of last year's tax bill.Pay 100% of the taxes stated on the previous year's tax return before applying any estimated payments, withholdings or refundable tax credits. If your adjusted gross income is more than $150,000 (or $75,000 if you are married and filing a separate tax return from your spouse), the safe harbor is 110% of the prior year's tax.
If you write a check to cover your tax bill and don't have enough money in your bank account to cover it, your bank may bail or "hold" the check. The IRS imposes a bounced check penalty of 2% of the check amount, unless it is less than $1,250. In that case, the fine is $25 or the amount of the check, whichever is less.
To avoid a bounced check penalty, make sure you have funds in your account to cover your payment before sending a check. Or make an overdraft protection with your bank.
How to get rid of tax fines
In a perfect world, you would never have to deal with IRS fines. Unfortunately, tax penalties are a reality for many people. Fortunately, the IRS is usually willing to work with people who make mistakes. This process is known as penalty reduction.
There are two common reasons the IRS would consider a sentence reduction.
1. Reasonable Reason
If you fail to file or pay taxes due due to extenuating circumstances, the IRS may agree to waive your penalties. Examples of reasonable causes might include a house fire, natural disaster, illness, or the death of a close family member.
2. Reduction of initial sentence
If you normally handle your tax filing obligations but just missed your filing deadline or payment due date, the IRS can do you a one-time favor. To qualify, you must have completed all of your tax returns, paid the outstanding balance, or entered into an installment agreement with the IRS, and have not suffered any prior penalties within the past three years.
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