The Types of Different IRS Penalties Compared, How to Avoid

The IRS Penalty Types Explained, How to Reduce Tax Penalties

IRS Penalty Types & How to Reduce Tax Penalties

For the past 5-10 years, the Internal Revenue Service has been very keen on enforcement of penalties associated with non-filing, late-filing, or incomplete filing of US Tax Returns such as Form 1040 — as well as missed international information reporting on forms such as the FBAR (Foreign Bank and Financial Account Reporting aka FinCEN Form 114); FATCA (Foreign Account Tax Compliance Act aka FATCA Form 8938), and Foreign Gifts and Trusts (Form 3520 and 3520-A). There are many different types of Tax and Reporting Penalties that a US Taxpayer may become subject to when are noncompliant with IRS rules and regulations – and some tax penalties can be worse than others. But, even if penalties are issued (or going to be issued), there are various avoidance, minimization, and abatement (removal) procedures available to Taxpayers to avoid or reduce those penalties. Let’s take a look at the potential tax penalties for IRS non-payment and penalty abatement.

IRS Penalties Based on Tax Liability

Penalties involving tax returns are usually based on the value of the tax liability. To put it in some context, if a person files their tax return late but has no tax liability — then presumably there would be no income tax penalty because there is no tax liability to base the penalty on (excluding issues such as reportable and listed transactions for example).

IRS Failure-to-File Penalty

The failure-to-file penalty is calculated based on how many months the Taxpayer goes without making payment for their tax liability. Generally, taxpayers get assessed a 5% penalty for each month up to a total amount of 25%.

IRS Failure-to-Pay Penalty

The failure-to-pay penalty is based on a .5% per month penalty of unpaid taxes up to a total value of 25%. Noting, that if a taxpayer has both a failure-to-file and failure-to-pay penalty, the total amount of the penalty per month will not exceed 5%.

IRS Substantial Understatement of Income Tax Penalty

The substantial understatement of income tax penalty comes into play if a person underestimates their tax liability by 10% or $5,000 – whichever is greater. This could be as a result of underreporting income or overembellishing expenses and deductions.  The penalty is generally going to be a 20% accuracy-related penalty of the portion of the underpayment if it was due to negligence or disregard.

IRS Fraud Penalty (IRC 6663)

In general, tax fraud penalties can be significant and the penalty is typically 75% of the tax liability due.

• • • “If any part of any underpayment of tax reqIf any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.”

International Assessable Penalties Based on Noncompliance

When it comes to international tax, offshore penalties are all the rage these days — with the Internal Revenue Service really dropping the hammer on unsuspecting taxpayers who may have made some mistakes with their reporting, usually by issuing assessable penalties that are “assessed” without any warning beforehand.

FinCEN Form 114 (FBAR)

The FBAR (which is not actually a “tax form,” although it is enforced by the IRS) is used to report foreign bank and financial accounts to FinCEN (Financial Crimes Enforcement Network). There are very different penalty structures — and depending on whether a taxpayer is willful or non-willful and which jurisdiction they reside in will help determine the extent of the FBAR violation (per form or per account). We have a detailed FBAR Penalty summary to assist you with understanding how FBAR penalties are enforced.

FATCA (Form 8938)

Form 8938 refers to FATCA (Foreign Account Tax Compliance Act). Form 8938 penalties tend to start at $10,000 per year but there are continuing failure-to-file penalties that can include an additional $50,000 when the Taxpayer does not ultimately file the form.

Form 5471

Form 5471 is used to report foreign corporations to the Internal Revenue Service. The failure to file the form may result in a penalty starting at $10,000 per year  — but that can go up significantly if there is a continuing failure to file.

Form 3520/3520-A

Forms 3520 and 3520–A are used to report foreign gifts and trust to the Internal Revenue Service. Depending on the value of the gift, the penalty can range upwards of 25% value of the gift – – which could be substantial, especially in a situation for example in which a student or recent graduate may have received a significant gift from a foreign family member in order to purchase a home. When it comes to foreign trust penalties, it will vary based on whether it is the beneficiary or the owner of the trust who is being penalized.

IRS Criminal Penalties Special Agent Investigation

In general, criminal penalties are rare — but they do happen. If the Internal Revenue Service’ Criminal Department and/or the Department of Justice decide to pursue a criminal tax investigation against the taxpayer for matters such as tax evasion, structuring, money laundering, etc. it may lead to significant financial penalties along with incarceration.

IRS Amnesty Programs

In order to avoid, minimize, or remove (abate) IRS penalties the US Government has developed various international and domestic tax amnesty programs to assist taxpayers with safely getting into compliance. It is important for taxpayers to carefully evaluate the different programs before making any proactive representation to the IRS because those representations and communications can be used against the taxpayer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax and specifically IRS offshore disclosure.

Contact our firm today for assistance.