FAQs: IRS & Tax Penalties

When I reviewed the tax bill that I received from the IRS, I discovered that a large part of my tax liability related to interest and penalties assessed by the IRS. Why interest and penalty were imposed and what can I do about them?

      The IRS regularly assesses interest and different types of civil penalties for various reasons. To begin with, interest on a given tax liability begins to accrue when the taxes are required to be paid. Generally, for individuals this is April 15 of each tax year. The interest rate imposed by the IRS is significantly higher than the market rate in order to encourage taxpayers to borrow from a bank or access lines of credit to remit taxes to the IRS. In addition to interest on the unpaid taxes, the IRS assesses interest on certain types of penalties.

      Another integral component of a tax liability is penalties assessed for a variety of reasons.

      An important type of tax penalties is accuracy-related penalty. The accuracy-related penalty is imposed for the following reasons:

•  Negligence or disregard of rules or regulations;
  
  
•  Substantial understatement of income tax;
  
  
•  Substantial valuation misstatement;
  
  
•  Substantial overstatement of pension liabilities; and
  
  
•  Substantial estate or gift tax valuation understatement.
  
  

      A penalty of 20% is applied to any portion of underpayment of tax attributable to accuracy-related violations. If you can show that the underpayment of tax was due to reasonable cause and you did not act with bad faith, the accuracy related penalties would not be applied.

      If the underpayment of tax was due to fraud, a penalty equal to 75% of the underpayment will be imposed. In addition, interest will accrue on the amount of penalty. Intent to evade tax needs to be present in order for the IRS to be able to assess fraud penalty. Mere negligence is not sufficient and the burden of proof is on the IRS to prove the element of fraud.

      You should remember that both the fraud penalty and the accuracy-related penalty are imposed when a tax return is filed. If you don't file a tax return, you will be subjected to a failure to file penalty. In addition to civil penalties, a nonfiler exposes himself or herself to criminal sanctions. For each month that the tax return is late, the IRS will assess a penalty of 5% of the tax due. The maximum amount of this penalty is 25% of the tax.

      Frivolous tax returns will trigger a $500 penalty in addition to other types of penalty. Such a tax return takes a frivolous position or is filed with a clear intent to impede the administration of the law. Other types of penalties are imposed for tax offenses such as failure to disclose reportable transactions, failure to file information returns or provide correct information and failure to timely deposit tax.

      If the IRS or the taxing authorities in Maryland, Virginia or Washington, D.C. have assessed civil tax penalties against you, consultation with an experienced tax attorney will help you understand the nature of those penalties and also help you in minimizing such tax penalties. The law provides that if the taxpayer has reasonable cause for incurring the tax debt, tax penalties could be reduced or eliminated. An experienced IRS tax lawyer is in the best position to evaluate your options in challenging the assessment of civil tax penalties.