How to Calculate Federal Tax Penalties
The Internal Revenue Service (IRS) imposes tax penalties on various taxpayer compliance and payment violations. Each penalty has separate guidance on when it is imposed, how the penalty is calculated and the maximum penalty allowable. Certain violations will cost more than others, and taxpayers must be aware of all the potential penalty liabilities that can be imposed for each type of violation.
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Failure to File
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Taxpayers with an outstanding tax balance owed to the IRS who do not file a tax return will be charged an additional five percent of the unpaid tax balance each month. The penalty stops accruing after the fifth month when the maximum 25 percent is reached.
Fraud
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An underpayment of tax attributed to a fraudulent position taken on a return will incur a 75 percent penalty immediately upon discovery of the fraudulent activity. For example, if you report the correct amount of income on a tax return, but create a fictitious deduction that reduces the tax liability by $1,000; the 75 percent penalty will only be imposed on the $1,000 underpayment and not the entire tax liability. Additionally, criminal penalties can be imposed on all activities that are determined to be fraudulent.
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Accuracy
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Filing a tax return with errors that understate the correct amount of tax owed to the IRS will incur a 20 percent penalty on the amount of tax liability not reported. This penalty applies to understatements attributed to negligence, substantial understatements and substantial valuation misstatements. However, the penalty will increase to 40 percent if understatement is due to a gross valuation understatement. Accuracy related penalties are inapplicable to taxpayers who intentionally provide incorrect information to evade taxes and are subject to fraud penalties and sanctions.
Unreported Tip Income
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Taxpayers who earn a portion of income from customer gratuities are required to report all tip income to the employer to report on a W-2. If you do not comply with this requirement, a penalty is imposed in an amount equal to 50 percent of the additional social security tax that you would be required to pay had all tip income been reported and included in gross income.
Estimated Tax
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Self-employed taxpayers and independent contractors who are not subject to federal tax withholding are required to make estimated income tax payments throughout the year. Total estimated tax payments made during the year must provide at least 90 percent of the current year's actual tax liability or 100 percent of the prior year's tax liability, whichever is smaller. The penalty is calculated as the sum of the federal short term rate plus three percent and is applied to the amount of underpayment not meeting the minimum requirements.
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References
- IRS Notice 746: Information about Your Notice, Penalty and Interest
- Cornell University Law School: United States Code: 26 U.S.C. § 6651
- Cornell University Law School: United States Code: 26 U.S.C. § 6663
- Cornell University Law School: United States Code: 26 U.S.C. § 6662
- IRS Tax Topic 306: Penalty for Underpayment of Estimated Tax
- Cornell University Law School: United States Code: 26 U.S.C. § 6654
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