Seven common tax penalties to avoid
You likely聽aren鈥檛 interested in raising your tax bill, but if you use bad judgment or make a serious error on your tax return, that鈥檚 exactly what will happen when the IRS hits you with a penalty.
But hey, at least you won鈥檛 be alone: The federal agency聽imposed almost 32 million civil penalties amounting to $12.4 billion on聽individual and estate and trust taxpayers in fiscal year 2015. The IRS reduced or forgave fewer than 10% of those penalties, which means it鈥檚 not easy to get out of them.
The moral of the story is don鈥檛 do anything that could generate a tax penalty. Here are seven common tax blunders to avoid.
1. Not filing your return on time
If you miss the April deadline and don鈥檛聽聽(which must be done聽by the April deadline, too), you鈥檙e probably on the hook for a late-filing penalty. That will be聽5% of the amount due for every month or partial month your return is late. The maximum penalty is 25% of what鈥檚 outstanding.
2. Not paying your taxes on time
Filing a return on time and paying your taxes on time are two different things, and they carry different penalties. So聽聽(even if you got an extension on filing your returns) you will get hit with more penalties.
First comes聽interest. It starts accruing on your outstanding balance on the day of the April deadline 鈥� again, even if you got a filing extension. The current rate is 4%, compounded daily (the interest rate can change quarterly).
The second hit聽is the late-payment penalty. It runs 0.5% of your unpaid taxes for each month your outstanding taxes are unpaid. The maximum penalty is 25%. You might be able to get out of this penalty if you can show reasonable cause, but you鈥檒l need to attach a written explanation to your return.
You can pay your tax bill in installments, but if you need more than 120 days to pay, you鈥檒l also get hit with a $120 fee (or $52 if you agree to a direct debit payment plan).
3.聽Filing really, really late
If your return is late by more than 60 days, you will probably have to pay a tax penalty of either $135 (adjusted for inflation) or what you still owe, whichever is smaller. The IRS also might look the other way if you can give a reasonable explanation for not filing on time, but again, you鈥檒l need to attach a written statement to your return.
If you really drag your feet or decide to go off the grid, the IRS might also file what鈥檚 called a substitute return. Basically, the agency prepares a return for you, using information it gathers from other sources. The problem here, of course, is that the IRS is guessing 鈥� it likely won鈥檛 consider聽. Then it will send you a tax bill that might be higher than what you would have paid if you had just done the calculations聽yourself. That bill will probably include interest and penalties, too.
4. Owing more than you think you do
This may happen after your file your return. If the IRS audits you and decides you didn鈥檛 pay enough in taxes, it will send you a new聽bill. And if you don鈥檛 pay the extra taxes in聽21 days, you鈥檒l face a penalty of 0.5% for each month (or partial month) they remain overdue. If the IRS decides you understated things too much聽(you were off by 10% or $5,000, whichever is higher) or that you negligently disregarded the tax rules, it can hit you with a penalty of 20% to 40% of the increase in tax. Sometimes you can get those penalties abated, but prepare to wrangle with the IRS.
5. Not buying health insurance
Not having health insurance can cost you:聽聽equal to the higher of either 2.5% of your household income or the sum of $695 per uninsured adult and $347.50 per uninsured child under 18. The penalty caps out at $2,085 or the annual premium for the national average price of a Bronze plan on the marketplace. If you were covered part of the year, the fee is prorated for each month you or your dependents didn鈥檛 have coverage.
6. 鈥楩orgetting鈥� about that foreign account
If you have one or more financial聽accounts聽outside of the United States that exceed a combined $10,000 value (for even just one day of the tax year) and purposely don鈥檛 report them, the IRS could take 50% to 100% of your balance if it catches you. The penalties are聽聽if the IRS thinks you did not hide the money on purpose.
U.S. citizens and resident taxpayers have to report money or property they transfer聽or receive through a foreign trust. If you get caught, you could face penalties of up to 35%.
If the value of an individual鈥檚聽overseas accounts聽was more than $50,000 on the last day of the tax year or more than $75,000 at any time during the year (or $100,000 and $150,000 for married couples), you may also need to file IRS Form 8938, which comes with its own set of penalties running into聽thousands of dollars.
7. Filing a frivolous tax return
If you want to write the IRS a nice letter stating that you think it doesn鈥檛 have the authority to tax you and therefore you owe nothing, think again. The IRS can assess a $5,000 penalty for filing frivolous returns, and you could be subject to many of the late-filing and late-payment penalties already mentioned. Plus, tax courts can add their own penalties for filing frivolous returns or frivolous court petitions.
If you decide to see what you can get away with and file a fraudulent return, you鈥檒l face a penalty of up to 75% of your underpaid taxes 鈥� on top of everything else. If you鈥檙e caught investing in or promoting abusive tax schemes, you could rack up $250,000 in fines and go to prison for up to five years.
And remember: Even though the federal government only has six years to charge you with tax evasion, it has a decade or more to collect those penalties.
Tina Orem is a staff writer at NerdWallet, a personal finance website. Email:torem@nerdwallet.com.
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