Avoid Paying Tax Penalties: Here’s How
Delay taxes for a stimulus check?
You work hard for your money, so why would you want to give it away for free?
Well, if you want to put yourself at risk of IRS tax penalties in 2021, then you’re doing exactly that.
And we’ve been surprised at the number of people who have no idea how tax penalties and tax interest actually work.
We know people who are delaying filing their taxes to get a $600 stimulus check.
And this is crazy because the amount of money they are losing in tax penalties and interests can be more than that PLUS they may have to pay taxes on the stimulus check.
So it’s clear that more people need to know about tax penalties in 2021, especially if you are a small business owner and need capital to survive.
That’s why in this post, we’re going to talking about 5 major things you need to know about tax penalties.
We’re going to discuss the common IRS tax penalties, when they apply, and how to avoid them. Let’s get started!
5 Things You Should Know About Tax Penalties
1. Common IRS Tax Penalties and How You Get Penalized
Let’s look at 3 common scenarios.
a. Failing to file a tax return on time
So what does that look like?
Well, the deadline for filing your federal income tax return and paying any tax you OWE is April 15th (or usually the next business day if April 15th falls on a weekend).
If you don’t file your return or get approved for an extension by that date, the IRS assesses a failure-to-file penalty, which starts at 5% of your unpaid taxes per month.
Let’s do the math.
So let’s say someone owes $2,000 then the IRS could charge you 5% of that each month, which would be a $100/month tax penalty.
The good news is that the IRS penalty won’t exceed 25% of your unpaid taxes.
So on $2,000, your failure-to-file tax penalty would be $500. And that is only if you’re late.
On top of that, if you file, but it’s more than 60 days after the due date (either April 15th or October 15th if you filed an extension) then there’s a minimum late filing penalty.
Last year, that penalty was $210 or an amount equal to 100% of the taxes you owe – whichever one is less.
So following our example earlier, someone who owes $2,000 could turn it into $710, just for filing late.
And we’ll say this again, we all work hard for our money so it doesn’t make sense to give it away, or in some cases, delay filing for a stimulus check.
So if you know anyone who is delaying filing for a stimulus check, please share this post with them.
b. Failing to pay your tax return on time
Now we know this is very similar to the first tax penalty so let us make a quick distinction.
There’s a penalty if you fail to file your taxes on time. And then there’s a penalty if you fail to pay your taxes on time.
So even if you file your taxes before April 15th, if you are late paying your taxes then you will face tax penalties.
The penalty for this is .5% of the unpaid taxes per month or part of a month that they go unpaid until the total tax penalty you owe reaches 25%.
Now there is one thing you should be aware of.
This penalty applies EVEN if you get approved for an extension to file your tax return.
So many people think because they file an extension they are exempt from tax penalties, but no.
The IRS is still going to charge you .5% until you pay off your taxes, which can basically be 6% a year.
Now we have investments in real estate and accredited funds, and we’re happy to earn 6%, especially with passive investments. So that’s a pretty big deal in our opinion.
However, one big relief is that if you get hit with a failure to file penalty and a failure to pay penalty, the IRS cuts you some slack.
For any month, where you get hit with both penalties, you will not be charged for the failure-to-pay penalty amount, which is great.
c. Failing to pay proper estimated tax
This one is especially important if you own a business or are self-employed because you don’t get taxes taken out of your check each month.
Instead, it’s up to you to make your estimated tax payments each quarter.
And if you fail to make your estimated tax payments or you don’t submit the accurate amount for your tax payments, you’re going to get hit with a tax penalty.
This applies if you expect to owe at least $1,000 in taxes after subtracting withholdings.
Now we’ve written a separate post all about estimated tax payments which you can read next so you can understand this step-by-step.
So those are the 3 most common reasons for tax penalties.
2. Getting a Refund
Now the second thing you should know is that you PROBABLY won’t get penalized if you’re getting a refund.
So for anyone who may be worrying right now, if the IRS is the one that owes you money then you can relax a little.
To elaborate further, our taxes help pay for government funding, which the government helps provide so many benefits for our country.
Like our military and our country’s infrastructure to name a couple of things.
So when you owe money and you’re late filing taxes, the government has less funding and you’re penalized for that.
Whereas if you are getting a refund, you are not filing taxes, which shouldn’t hurt government funding at all.
That being said, don’t take this as encouragement for a late filing. It’s still best to file your tax return on time to 100% avoid penalties.
3. Owing Interest
If you owe taxes and find that you can’t pay it all back in one lump sum, the IRS offers installment agreements that allow you to pay your bill over time.
But if you get a monthly payment plan, it will include interest in addition to a reduced failure-to-pay penalty.
The interest rate changes every 3 months. But in general, it can be anywhere between .5% – 5%
The way we think about it is that when you owe taxes, it’s because you didn’t pay your fair share of taxes to the IRS.
This means you are basically borrowing money.
So if you can’t pay the IRS back in time, they are basically converting your taxes owed into a loan with interest.
So if you are not crazy about having loans or debt, that’s another reason why you would want to pay it off ASAP.
4. Neglecting Taxes
The fourth big thing you should know about tax penalties is that if you wait too long, you could face other consequences.
If you owe the IRS and you decide to straight GIVE UP on filing your tax return, some of the penalties we talked about would be the least of your concerns.
You see, the IRS will send you several letters telling you about the owed amount, tax penalties, and tax interest.
And if you ignore them, the IRS could determine that you are evading taxes or committing tax fraud, which could put you on the hook for legal fines.
And even jail time.
So let’s definitely avoid that one.
5. Request a Penalty Waiver
There are 3 ways you can do this, depending on your situation and whether you’ve paid penalties in the past.
a. First-time penalty abatement
If you haven’t had any penalties for the past 3 years or just never filed taxes in the US before, then you can request a first-time penalty waiver.
To qualify, you must have filed your current return on time or filed an extension and made arrangements to pay what you owe.
Pro-tip: It’s better to wait to request abatement until you’ve paid the full amount since penalties and interests can accrue on any open balance.
b. Reasonable cause
If you have a legit reason for not being able to file taxes on time then you can request relief.
Here are some things IRS considers to be reasonable:
- natural disasters or similar hazard events (like what’s happened in Texas)
- inability to obtain relevant tax records
- serious illness
- incapacity or unavoidable absence of tax payment or member of an immediate family
These are just some examples, but the IRS will consider other reasons if you can show that you tried to meet your tax obligations in good faith.
Note that not having the money to pay your tax bill is not a legit reason for not filing or paying on time.
Also, keep in mind that you will likely need to show evidence, so you may need to show a hospital bill, court record, or insurance claim, for example.
c. Misled by advice from the IRS
If you can show that the IRS gave you incorrect advice, in writing, then you can request a waiver.
So in conclusion, the bottom line is this: Avoiding tax penalties is much easier if you are owed a refund.
But if you owe taxes, you still don’t have to worry about penalties as long as you file on time, pay on time and pay the correct amounts.
Keep in mind that if you do need more time, you can still request an extension for 6 months which can help reduce (but not avoid) tax penalties.
And if you truly were not aware and this is a rare occurrence where you had to pay tax penalties then you can request a waiver of penalty if it is your first time or it’s been 3 years.
Hopefully, you now understand how tax penalties work and you can do your best to avoid them for you to keep your hard-earned money.
And since we’re in the middle of tax season right now, if you have a business then our tax preparation and tax planning services can help you navigate through the tough tax system.
If you’re looking for a good company or person to work with, please don’t hesitate to contact us today.