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Civil tax penalties are designed to encourage compliance with United States tax laws including timely filing and payment. However, civil tax penalties have a reputation for being severe. For example, California’s 50% late payment penalty for cannabis distributors or the IRS’s 75% civil fraud tax penalty is considerable compared to contractual late payment penalties with which most taxpayers are familiar. With excessive penalties and interest, many taxpayers accumulate tax debt with seemingly no hope of repayment. Nevertheless, an experienced tax attorney can help these taxpayers secure penalty relief in conjunction with tax resolution strategies such as installment agreements with the IRS or the State of California.
Civil vs. Criminal Tax Penalties
Penalties are imposed by the IRS in order to encourage compliance with tax laws and regulations. Penalties fall into two categories: criminal and civil penalties. Criminal penalties are penalties that involve imprisonment and jail time. They’re usually not imposed unless the infraction is grave. Civil penalties are more common and they’re usually in the form of additional payment. There are around one hundred and forty civil penalties that the IRS can impose. Some civil penalties however are more common than others. Civil penalties are usually imposed in the following scenarios.
5% Failure To File Penalty
A civil penalty is imposed when a taxpayer fails to file his tax return on the annual due date. For reference, this date is usually April 15 or April 19, but it may be extended in some instances. The amount of the failure to file penalty may vary depending on the circumstances. A civil penalty of 5% of the total tax bill for every month (or including partial months) the taxpayer fails to file is imposed initially. An additional penalty of either 100% of the balance due or $210 (whichever is lesser) is imposed if the filing is late for more than 60 days. Lastly, a penalty may be increased to 15% per month (or partial month) if the IRS finds that the late filing is due to fraud. This penalty based on fraud is capped at 75% of your underpayment due to fraud and requires the IRS to provide clear and convincing proof of fraud.
.5% Failure to Pay Penalty
The failure to pay penalty is different from the ‘failure to file‘ penalty. A failure to pay penalty is imposed when the taxpayer files his tax return on time but does not pay the amount owed by the deadline. The late payment penalty is usually imposed at .5% of the unpaid taxes per month (or partial month), up to a maximum penalty of 25% of the unpaid taxes. There is a six-month extension to pay the balance if the taxpayer has already paid 90% or more.
75% Civil Fraud Penalty
The civil fraud penalty is one of the most severe under U.S. tax law. Pursuant to IRS Section 6663 the IRS may impose a 75% penalty on the portion of underpaid tax attributable to fraud. 75% is a large sum to impose as a tax penalty, and the draconian penalty is designed to disincentivize tax fraud.
The only silver lining to the civil fraud penalty is that it cannot be imposed in addition to the 20% accuracy-related penalty. In other words, the IRS much choose whether to assess the 20% accuracy-related penalty or the 75% civil fraud penalty; they may not impose both. (IRM 220.127.116.11.3 Coordination with other penalties “The IRC 6662(a) penalty does not apply to (1) Any portion of an understatement on which the fraud penalty (IRC 6663) is imposed.”
20% Accuracy-Related Penalty
Internal Revenue Code Section 6662 imposes a 20% penalty on the portion of tax underpaid due to negligence or a substantial understatement of income tax owed. This penalty is designed to discourage taxpayer negligence in calculating their tax obligations.
Accuracy penalties are imposed if there are errors in the tax returns filed by the taxpayer. Some common errors that may result in accuracy penalties are:
- Negligence or disregard for tax laws in returns
- Failure to disclose a foreign asset
- Claiming a deduction or benefit based on an improper transaction