Life happens. You miss a tax deadline or can’t pay the taxes you owe. While you might face IRS penalties, these penalties are often preventable. In some cases, you might even be able to get them waived.

So rather than panicking or avoiding the issue, let’s look at what kinds of penalties the IRS charges, how to prevent them, and options for getting them removed or reduced.

Overview of IRS Penalties

The IRS levies four main types of penalties, and you might even be responsible for a few penalties simultaneously.

1. Failure to File

Failing to file your taxes by the tax deadline each year can result in a failure to file penalty, which is 5% of your unpaid tax for each month or part of a month that your tax return is late.

The maximum failure to file penalty is 25% of the taxes owed, so your penalty maxes out at five months. However, the IRS also charges interest on your past-due balance, so you should file as soon as possible. That interest rate changes each quarter, but as of Q2 2023, it’s 7% for individuals and most businesses.

If your return is more than 60 days late, the minimum failure to file penalty is $435 or 100% of the tax due with your return, whichever is less.

2. Failure to Pay

If you file your federal income tax return but don’t pay the balance owed, you’ll owe a failure to pay penalty. This penalty is 0.5% of the unpaid amount per month or partial month. Like the failure to file penalty, it won’t exceed 25% of your outstanding tax balance.

If coming up with the cash to pay your taxes is the issue, you can set up an IRS installment agreement to pay the amount owed in fixed payments over a predetermined term. When you have an installment agreement, the IRS reduces the penalty to 0.25% per month. So although you still accrue penalties and interest while on an IRS payment plan, the penalties are less than they would be without one.

In some cases, both the failure to file and failure to pay penalties apply simultaneously. If you’re in this situation, the IRS reduces the failure to file penalty by the amount of the failure to pay penalty for the month so you’ll owe a maximum of 5% of the tax owed total per month.

3. Underpayment of Estimated Tax by Individuals

The federal income tax system in the U.S. is a ‘pay as you go’ system, meaning you must pay taxes as you earn money rather than in a lump sum when you file your tax return.

For people with W-2 jobs, this pay-as-you-go requirement is handled by their employers, who withhold federal income taxes and FICA tax from their paychecks. However, if you’re self-employed or have income that isn’t subject to withholding, such as rental income, royalties, or investment income, you may be required to make quarterly estimated tax payments.

If you don’t have enough tax withheld from your paycheck or make insufficient estimated tax payments and owe more than $1,000 when you file your return, the IRS may charge an underpayment of estimated tax penalty.

Unlike other IRS penalties, the underpayment penalty isn’t a standard percentage. Instead, the IRS calculates your penalty by taking the current interest rate and multiplying it by the difference between the amount you should have paid each quarter and what you actually paid.

4. Underpayment of Estimated Tax by Corporations

Corporations must also make estimated payments if they expect to owe more than $500 when they file their corporate income tax return.

Like individuals, if you don’t make estimated payments (or you underpay), the IRS charges an underpayment of estimated tax by corporations penalty. The underpayment penalty applies by quarter, so even if you’re due a refund at tax time, you may owe a penalty for any quarter you underpaid your estimated tax due.

How to Avoid IRS Penalties (Or Get Them Removed)

The easiest way to avoid IRS penalties is to file and pay your taxes on time. This includes all estimated tax payments and taxes owed by the filing deadline.

Here are a few quick tips to help you avoid IRS penalties:

• If you can’t file your taxes by the deadline—usually April 15—you can request an extension. You’re still responsible for paying taxes due by April 15, so try to pay what you think you owe by that date. As long as you file by the extended deadline (usually October 15), you can avoid failure to file penalties.
• Pay as much of the tax due by the tax due date. If you can’t afford to pay your taxes in full by the deadline, pay as much as possible. Then enroll in a payment plan to extend the time you have to pay the remainder. You’ll still owe penalties and interest, but not as much.

You may be able to get the IRS penalties removed, but the IRS only agrees to penalty relief in certain circumstances:

• First-time abatement. If you previously didn’t have to file a return or haven’t had any penalties for the last three years, are current with your tax filing requirements, and have paid or arranged to pay any tax you owe, the IRS might agree to a one-time penalty abatement. You can call the IRS at the phone number shown on your penalty notice to request first-time abatement.
• Reasonable cause. If you didn’t file or pay your taxes due to reasonable cause, the IRS might agree to waive your penalties. Some examples of situations that qualify as reasonable causes might include a fire, natural disaster, or the death or serious illness of an immediate family member. Again, you can request penalty abatement for reasonable cause by calling the IRS at the number shown on your penalty notice. The IRS may ask you to provide documentation proving your circumstances, such as insurance records or a death certificate.

The best way to avoid IRS penalties is to file and pay your taxes on time. However, if that’s not possible, don’t ignore your responsibilities. File for an extension, pay as much as you can afford, and apply for an IRS installment agreement to avoid excessive penalties and interest charges.

If you need help estimating the amount you owe, filing your returns, or handling IRS notices, contact NewWay Accounting. We can help you stay compliant so IRS penalties and interest are a thing of the past!