Avoiding Tax Return Fees & Penalties
January 5, 2010
The increasing complexity of tax law each year causes creates unnecessary penalties and tax return fees for countless Americans. Having a basic understand of what the most common fees and penalties are can help raise your awareness in order to prevent them. Below is a list of the most common tax return fees and penalties and how these can be avoided.
Tax Preparation & Filing Fees
What They Are: Many tax preparers can charge some steep prices for preparing and filing your tax returns. Sometimes this can be justified if you have a complex tax return and they can help you spot deductions that you would not have noticed but many times they are not required.
How to Avoid: If you do not have a complex return and want to avoid the fees of a tax professional there are several options for you. If you made less than $56,000 in 2009 then you can file for free using the IRS’s FreeFile. Free file is a program similar to TurboTax, but allows you to file your taxes for free. If you made more than $56,000 then you can use programs offered by companies such as TurboTax or H&R Block at Home. These programs make it fairly simple to prepare your tax return, take proper deductions, and electronically file your return.
Failure to File Penalty
What Is It: The failure to file penalty can be one of the harshest tax penalties you can receive. This penalty really only applies to those individuals that owe taxes. This penalty is 5% a month on the amount of taxes you owe after the filing deadline. The maximum for this penalty is 25%, which will be reached if a return is not filed for 5 months after the due date. As you can see, this penalty adds up fairly quickly and there are also additional penalties that come along with this that will be discussed below.
How to Avoid: The easiest way to avoid this penalty is to be sure to file your taxes by the tax filing deadline. Most people fail to file because they know they will not be able to pay. One important thing to know is that the failure to pay penalty is significantly less than the failure to file penalty, so filing your taxes is the easiest way to avoid hefty penalties.
If you cannot file on time then you can also consider filing for an extension. An extension will allow you to extend the filing date from April 15th to October 15th. Tax payments are still due by April 15th, but if you file an extension and the IRS has 90% of taxes owed you will avoid the failure to file penalty and the failure to pay penalty (discussed below).
Failure to Pay Penalty
What Is It: The failure to pay penalty is 0.5% for each month that the tax goes unpaid. This total penalty cannot exceed 25% of your total tax liability. As you can see, this penalty is much lower than the failure to file penalty.
How to Avoid: The most obvious way to avoid this is to pay your taxes in full. You can also reduce this penalty by paying as much as you can (assuming you cannot pay in full). If paying your taxes in full is not an option then it is a good idea to consider an Installment Agreement.
With an Installment Agreement, you will be allowed to pay off the tax liability in monthly increments or payments just like a car loan. You will still be charged interest (discussed below), but the failure to pay penalty will be about 50% less (.25% per month) than the normal monthly failure to pay penalty (.5%). To apply for an installment agreement you can use IRS form 9465 or use the Online Payment Agreement Application.
Tax Underpayment Interest/Penalty
What Is It: When there is an underpayment of taxes owed the IRS will charge interest on this outstanding balance. This amount is determined by the short-term federal rate (currently about 1%), plus an additional 3% bringing up the total interest to around 4% for individual taxpayers. This interest in addition to any failure to file or failure to pay penalties that are incurred.
How to Avoid or Reduce: This interest can be avoided if taxes are paid in full. If taxes cannot be paid in full, paying as much as you can obviously reduces your total underpayment interest.
If you were or are a victim of some of these penalties, in certain situations, these penalties can be removed. Penalties constitute a large portion of taxes owed and if you have been charged steep penalties then you should look to abate penalties often times called “Penalty Abatement.” Under the IRS penalty abatement provision, the IRS will remove some penalties if the taxpayer can prove that they had a legitimate reason for not filing or paying their taxes such as loss of a loved one, serious illness, records destroyed, or any other event that occurred without your control.
The tips above can help prevent unnecessary charges, penalties, and interest with your annual taxes. If you know you are going to have a problem with your taxes, it is best to communicate with the IRS rather than trying to avoid them. The IRS has become more helpful at helping individuals with various tax problems; they even have an independent organization called the Taxpayers Advocate that offers free assistance to taxpayers that you should reach out to if not your tax professional.
Thanks to Manuel Davis for this contibuting this article on tax return fees & penalties. Manuel is a tax accountant who has been helping individual taxpayers with various IRS back tax related problems.
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All posts by Ben Edwards