8 Tax Penalties Your Business Should Know About
Most business owners are well acquainted with tax penalties - they’re harder to avoid than anyone wants to admit. But what are tax-related penalties? In this article, I’ll break down the most common penalties for you.
What is a Tax-Related Penalty?
A tax-related penalty is an amount charged by a federal (like the IRS) or state agency (like your state treasury) in addition to the amount of taxes you already owe.
Who Can Get a Tax-Related Penalty?
A penalty can be owed by an individual or a business depending on who the IRS determines is liable. For some penalties, like Trust Fund penalties for example, both the individual and business are responsible for the penalty bill.
Reasons You Might Have a Tax-Related Penalty
Penalties are applied to tax bills for various reasons. The IRS, the state in which you reside, and the state in which your business is registered, may all apply a penalty for any of the following reasons*:
- Failure to file your tax return on time
- Failure to pay any tax you owe on time
- Failure to pay any tax you owe through the correct method
- Failure to prepare an accurate tax return
- Failure to provide accurate information on your tax return
8 Common Types of Tax-Related Penalties
The majority of penalties taxpayers come across are issued by the IRS. Here’s a list of the most common tax-related penalties and their amount:
- Information Return: applies to taxpayers who don’t file or provide required information on their return or payee statement (like a 1099) correctly by the tax due date. Information return penalties can be up to $3000.
- Failure to File: applies when you don’t file your tax return by the due date. The Failure to File Penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late. These penalties won't exceed 25% of your unpaid taxes.
- Failure to Pay: applies when you don’t pay the tax you owe by the due date. The Failure to Pay Penalty is 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid. These penalties won’t exceed 25% of your unpaid taxes.
- Accuracy-Related: applies when you don’t claim all your income, or when you claim deductions or credits for which you don’t qualify. For example, if you claim a child you don’t have as a deduction. (Don’t do that.) In cases of negligence or disregard of the rules or regulations, the Accuracy-Related Penalty is up to 20% of the correctly calculated tax amount. In cases of substantial understatement (like you claimed $10,000 in business expenses for a business you didn’t have), the penalty is 20% of the correctly calculated tax amount.
- Failure to Deposit: applies when you don’t pay employment taxes accurately or on time. This is one of the hardest penalties to deal with, so it’s at the top of the list of penalties we recommend you avoid like the plague. The penalty is up to 15% of unpaid taxes.
- Dishonored Checks: applies when your bank doesn’t honor your check or other forms of payment. Also known as a bounced check. (Don’t do this, either.) The penalty is 2% of the amount of the check.
- Underpayment of Estimated Tax by Corporations: applies when you don’t pay estimated tax accurately or on time for a corporation. If your corporation doesn’t pay enough estimated tax, the penalty is 10% of the amount you should have paid. If you don’t pay any estimated tax, the penalty is 25% of the amount you should have paid. For a corporation, that can mean a huge penalty.
- Underpayment of Estimated Tax by Individuals: applies when you don’t pay estimated tax accurately or on time as an individual. The penalty here is very dependent on the individual and the amount owed. We can’t give you specific numbers here, but the IRS says “The penalty upon conviction can be either a fine of up to $1,000 or imprisonment for up to 1 year or both.” (So really, really don’t do that.)
So - What Should You Do If You Get a Penalty?
If you do end up with a tax penalty, there are 3 actions you could take:
- Pay the penalty along with any balance owed to the agency that issued the penalty
- Provide an explanation as to why the penalty should be waived or forgiven, and ask the issuing agency to waive/forgive the penalty
- Appeal the penalty to the agency that issued it. (In other words, admit to doing the wrong thing and apologize.) When appealing a penalty, make sure you reach out to the agency first for the appropriate steps to take. There is usually a window you need to appeal inside of, otherwise, you won’t be able to appeal at all.
Not taking any action if you receive a tax-related penalty increases future tax bills with the issuing agency and could cause future issues with tax credits and/or refunds.
How Can You Avoid Tax-Related Penalties?
Put simply: pay your taxes on time, in full, and with all of the required information. File accurate returns, pay your tax owed by the due date, and provide any information returns by the deadline.
*This list is not a complete list of reasons an individual or business may receive a penalty, but of the most common tax-related reasons a penalty may be incurred.