The Internal Revenue Service (IRS) imposes a variety of penalties on taxpayers to encourage compliance with tax laws and regulations. In 2023, several changes and updates to IRS penalties have taken effect, impacting both individual taxpayers and businesses. The IRS imposed a whopping $7 billion in tax penalties in 2023, a record-high that marks a nearly 300% increase from the prior year.
The majority of the fines were levied against those who underpaid their estimated quarterly income taxes, which is predominantly freelancers, gig workers and other self-employed individuals.
In fiscal year 2023, the average estimated tax penalty jumped to $500 from $150 the previous year, according to IRS data. That’s because the IRS penalty for individuals who fail to make accurate, on-time payments – or don’t pay their estimated taxes at all – surged to 8% at the beginning of October, nearly triple the previous 3% rate.
Below is an overview of the key IRS penalties imposed in 2023, offering insights into how to avoid them and what to do if you face a penalty.
Common IRS Penalties in 2023
- Failure to File Penalty
- Description: This penalty is imposed on taxpayers who fail to file their tax returns by the due date, or fail to file an extension.
- Penalty Rate: Generally, the penalty is 5% of the unpaid taxes for each month (or part of a month) that a tax return is late, up to a maximum of 25% of the unpaid taxes.
- Changes in 2023: For certain filers, including some small businesses and self-employed individuals, the IRS has increased the threshold for waiving this penalty due to reasonable cause.
- Failure to Pay Penalty
- Description: Imposed on taxpayers who do not pay the tax owed by the due date.
- Penalty Rate: The penalty is 0.5% of the unpaid taxes for each month (or part of a month) that the tax is not paid, up to a maximum of 25% of the unpaid taxes.
- Changes in 2023: The IRS has adjusted the criteria for installment agreements, making it easier for taxpayers to avoid this penalty by entering into a payment plan.
- Accuracy-Related Penalty
- Description: This penalty applies to taxpayers who underpay their taxes due to negligence or disregard of rules and regulations, or due to substantial understatement of income tax.
- Penalty Rate: Typically 20% of the underpayment.
- Changes in 2023: The IRS has clarified the definitions of “negligence” and “substantial understatement” to provide clearer guidelines for taxpayers.
- Estimated Tax Penalty
- Description: Imposed on taxpayers who fail to pay enough tax throughout the year, either through withholding or estimated tax payments.
- Penalty Rate: Calculated based on the amount of underpayment, the period of underpayment, and the federal short-term interest rate plus 3%.
- Changes in 2023: The IRS has provided more detailed guidance on how to calculate estimated tax payments and avoid this penalty, especially for self-employed individuals and those with fluctuating income.
- Failure to Deposit Penalty
- Description: Imposed on businesses that fail to deposit employment taxes, such as payroll taxes, on time.
- Penalty Rate: The penalty ranges from 2% to 15% of the unpaid tax, depending on how late the deposit is.
- Changes in 2023: The IRS has implemented a new educational initiative to help small businesses understand and comply with deposit requirements, potentially reducing the incidence of this penalty.
- Trust Fund Recovery Penalty
- Description: This penalty applies to business owners and responsible persons who willfully fail to collect, account for, and pay over trust fund taxes, such as employment taxes.
- Penalty Rate: 100% of the unpaid trust fund tax.
- Changes in 2023: The IRS has increased enforcement efforts and is utilizing advanced data analytics to identify potential cases of non-compliance more efficiently.
How to Avoid IRS Penalties
- Timely Filing and Payment: Ensure all tax returns are filed on time, and any taxes owed are paid by the due date. Consider using electronic filing and payment methods to avoid delays.
- Accurate Reporting: Double-check your tax return for accuracy even when it is prepared by a tax professional.
- Stay Informed: Keep up with changes in tax laws and IRS regulations to ensure compliance. The IRS website and professional tax advisors can be valuable resources.
- Use Installment Agreements: If you cannot pay your taxes in full by the due date, apply for an installment agreement with the IRS to avoid the failure to pay penalty.
- Educational Resources: Take advantage of IRS resources and educational initiatives designed to help taxpayers and businesses understand their obligations.
What to Do If You Face an IRS Penalty
- Understand the Notice: Carefully read any notices from the IRS to understand the nature and amount of the penalty.
- Request an Abatement: If you believe the penalty was assessed in error or if you have reasonable cause, you can request an abatement or reduction of the penalty.
- Appeal the Penalty: If your request for abatement is denied, you have the right to appeal the decision within the IRS.
Conclusion
IRS penalties can be substantial, but understanding the reasons for their imposition and how to avoid them can save taxpayers and businesses significant amounts of money and stress. Staying informed about changes in tax laws and maintaining good filing and payment habits are key strategies for avoiding penalties. If you do face a penalty, knowing your options for abatement and appeal can help mitigate its impact.