Making errors while filing tax return is common, especially if a taxpayer is filing last-minute. Although, not every tax error is harmful, some tax errors can have severe tax consequences in the form of penalties and interest.
The following is an overview of some very common tax errors that U.S. taxpayers make and the applicable penalties in each case.
U.S. Tax Errors & Associated Penalties
Failure-to-file Tax Return & Pay Taxes in Time
U.S. taxpayers are required to file their tax return, report all sources of income, and pay taxes by the deadline unless there is a reasonable cause for the delay or avoidance. Reasonable cause includes fire, death, serious illness in the family, or other unpredictable events.
The failure-to-pay penalty is one-half of one percent for each month, or part of a month, up to a maximum of 25%, of the amount of tax that remains unpaid from the due date of the return until the tax is paid in full. The one-half of one percent rate increases to one percent if the tax remains unpaid 10 days after the IRS issues a notice of intent to levy property. Interest is also charged on the amount of unpaid tax.
If a taxpayer owes tax and does not file on time, there is also a penalty for not filing on time. The failure-to-file penalty is usually five percent of the tax owed for each month, or part of a month that the return is late, up to a maximum of 25%. If the return is over 60 days late. There is also a minimum penalty for late filing of $210 or 100 percent of the tax owed, whichever is lower.
If the taxpayer does not have reasonable cause, the taxpayer can apply for first-time penalty abatement (FTA) waiver if they have always filed their tax return and paid the taxes in time.
Estimated Tax Amount Calculation Error
The United States income tax system is a pay-as-you-go tax system, which means that taxpayers must pay income tax as income is earned or received during the year. This is done either through withholding or by making estimated tax payments. If not enough tax was paid throughout the year, either through withholding or by making estimated tax payments, the taxpayer may have to pay a penalty for underpayment of estimated tax. The penalty resembles an interest payment and the amount of penalty is tied into the interest tables.
There are only two situations available to obtain relief from estimated tax penalties:
- If the payment was not made due to a casualty, disaster or other unusual circumstances.
- The taxpayer retired (after reaching age 62) or became disabled during the tax year or in the preceding tax year for which estimated payments were required, and the underpayment was due to reasonable cause and non willful neglect.
A taxpayer may also get these penalties abated if they can prove that the IRS made an error, such as crediting a payment to the wrong tax period, or if calculating the penalty using a different method (such as the annualized income installment method). This could help reduce or even eliminate the penalty. In these situations, it may be a good idea to consult with a tax professional before proceeding.
Inaccurate or Incomplete Tax Filing
The amount of an accuracy-related penalty equals 20 percent of the portion of the underpayment attributable to the taxpayer’s negligence or disregard of rules or regulations or to a substantial understatement of income. A taxpayer can obtain relief from this penalty if they can demonstrate that they properly disclosed the tax position in the return and that they had a reasonable basis for taking that position.
Generally, an “understatement” is the difference between:
- The correct amount of tax, and
- The tax reported on the return.
NOTE that, the understatement of tax is substantial if it exceeds the greater of $5,000 or ten percent of the tax that must be shown on the return.
Generally, there should be a reasonable basis the taxpayer made an effort to determine the proper tax liability.
Again, reliance on a competent tax professional will greatly improve the odds of obtaining relief from tax penalty. Other possible grounds for relief include computational errors and reliance on an inaccurate W-2, 1099 or other information statement.
That being said, taxpayers should not ignore any notice or letter from the U.S. IRS, as this could lead to increased penalties and interest. It should be noted that the IRS does not abate interest on unpaid taxes. Interest is charged by law and will continue until the account is fully paid. Mistakes can happen, on both ends of the tax filing process, and swift action should be taken in these instances to mitigate as much as possible any ensuing penalties.
AG TAX LLP CAN HELP
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
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- Canadian Personal and corporate tax returns
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