Appendix B
Tax Penalties
Most taxpayers try to do the right thing, but needless to say, taxes are confusing and tax responsibilities can be overwhelming. As Wernher von Braun, the father of the U.S. space program, said “We can lick gravity, but sometimes the paperwork is overwhelming.” If you make mistakes, you don't file on time, or you don't file at all, you can be penalized. In addition, interest may accrue on the penalties as well as on any unpaid taxes.
In recent years, many of the penalty rules have changed. Amounts have increased, and new rules have been added. What's more, many penalties with dollar amounts can be adjusted annually for inflation. This appendix contains a roundup of common civil penalties. Criminal penalties are not discussed here.
Failure to File a Tax Return or Pay Tax
If you fail to file your return on time—by the due date or the extended due date if you obtain a filing extension—you will be subject to a late filing penalty. A penalty can apply in some cases even if you have deposited your taxes on time and owe no additional tax with your return.
The late filing penalty is usually 0.5% of the amount due for each month or part of a month that the return is late, up to a maximum of 25% of the tax due.
However, the penalty increases to 15% of the amount due for each month or part of a month that the return is late, up to a maximum of 75% of the tax due, if the failure to file is fraudulent. If the 2022 return is more than 60 days late, the minimum penalty is $450 or 100% of the tax shown on the return, whichever is less. The dollar amount may be adjusted for inflation. Check the Supplement for any changes in the penalty for 2023 returns filed in 2024.
Failure of a Partnership to File a Return
For 2022 returns, the penalty is $220 multiplied by the number of partners during any part of the year. The penalty is per month (or part‐month) that the return is late, up to a maximum of 12 months.
Failure of an S Corporation to File a Return
For 2022 returns, the penalty is $220 multiplied by the number of shareholders during any part of the year. The penalty is per month (or part‐month) that the return is late, up to a maximum of 12 months.
Failure to File Retirement Plan Returns and Notices
For late filings after 2019, the penalty for failing to timely file Form 5500 (any in the series) is up to $250 per day (a maximum of $150,000 per plan year). The penalty for failing to provide income tax notices is up to $100 for each failure (a maximum of $50,000 for the calendar year).
Failure to File Correct Information Returns
As a small business owner, you may have to file various information returns, including W‐2s for employees and 1099‐NEC for independent contractors for payments in 2022. Information return obligations are explained in Appendix A. Table B.1 shows the penalty amounts for delinquencies for small businesses with average annual gross receipts for the most recent 3 years of $5 million or less that fail to furnish correct information returns (penalties for businesses with higher gross receipts are not covered here). As you can see, the quicker you correct a problem, the lower your penalty amount will be. These are the penalty amounts for 2022 returns filed in 2023.
TABLE B.1 Penalties for Small Businesses for Information Returns
| Scenario | Daily Penalty | Maximum Penalty |
|---|---|---|
| General rule | $290 | $1,177,500 |
| Corrected on or before 30 days after required filing date | $50 | $206,000 |
| Corrected after 30th day but on or before August 1 | $110 | $588,500 |
If the failure to file correct information returns is due to intentional disregard of the filing requirements (or the correct information reporting requirements), different penalty amounts apply; there is no limit on such penalty.
De Minimis Exception
Usually, if there is an error on Form W‐2 it must be corrected on Form W‐2c. However, no correction is needed and no penalties are imposed for de minimis errors. This is defined as amounts less than $100 for Social Security and Medicare taxes, or $25 for income tax withholding. However, an employee can request a corrected form, and an employer must comply with the request or be subject to a penalty.
Failure to File Correct Payee Statements
If you are required to provide employees with Form 1095‐B or 1095‐C but fail to do so or are late in doing so, you may be subject to a penalty unless the de minimis exception described earlier applies. Table B.2 shows the penalty amounts for small businesses with average annual gross receipts for the most recent 3 years of $5 million or less (penalties for businesses with higher gross receipts are not covered here). As you can see, the quicker you correct a problem, the lower your penalty amount will be. These are the penalty amounts for 2022 returns filed in 2023.
If the failure to file correct payee statements is due to intentional disregard of the filing requirements (or the correct information reporting requirements), different penalty amounts apply; there is no limit on such penalty.
Accuracy‐Related Penalties
If you make certain mistakes, you may owe a tax penalty. Penalties for these mistakes are called accuracy‐related penalties. They include:
- Negligence or disregard of IRS rules and regulations
- Substantial understatement of tax liability
- Overvaluation penalty
- Undervaluation of property on a gift tax or estate tax return
- Claim of benefits from a transaction lacking economic substance
- An undisclosed foreign asset
- Claiming a basis of property in excess of the amount reported on an estate tax return
TABLE B.2 Penalties for Small Businesses for Payee Statements
| Scenario | Daily Penalty | Maximum Penalty |
|---|---|---|
| General rule | $290 | $1,177,500 |
| Corrected on or before 30 days after required filing date | $50 | $206,000 |
| Corrected after 30th day but on or before August 1 | $110 | $588,500 |
Negligence or Disregard of IRS Rules and Regulations
The penalty for failing to make a reasonable attempt to comply with the tax law is a penalty of 20% of the portion of an underpayment attributable to the negligence. If you take a position contrary to IRS revenue rulings, notices, or regulations, you can avoid the penalty by having a reasonable basis for your position and telling the IRS so on Form 8275 (for a position contrary to IRS rulings or notices) or Form 8275‐R (for a position contrary to regulations). Even if you don't file this form, you can still avoid the penalty if you can show you had reasonable cause, explained later in this appendix.
Substantial Understatement of Tax Liability
If you understate your tax liability by overstating your deductions or omitting income, you may owe a 20% penalty. An understatement is defined as substantial if it exceeds the greater of $5,000 or 10% of the proper tax (5% of the proper tax when it comes to the qualified business income deduction). Alternatively, you may be subject to the negligence penalty explained earlier.
Overvaluation Penalty
If you donate property to charity and the value claimed on your return is 150% or more of the correct value that results in an underpayment exceeding $5,000, you may owe a penalty of 20% of the underpayment. If the overvaluation is 200%, the penalty becomes 40% of the underpayment.
The 20% penalty is avoided if you based your claimed deduction on a valuation from a qualified appraiser. However, this action does not avoid the 40% penalty.
Undervaluation of Property on a Gift Tax or Estate Tax Return
If you give an interest in your business to your children or others and you undervalue the interest that results in an underpayment of more than $5,000, you may incur a penalty of 20% of the underpayment.
Claim of Benefits from a Transaction Lacking Economic Substance
If you engage in a tax transaction that makes no sense economically, you may owe a penalty of 20% of the underpayment. The penalty doubles to 40% if you did not adequately disclose the transaction on your return. You may avoid the 20% penalty if you have reasonable cause (explained later), but you can't escape the 40% penalty by showing reasonable cause.
An Undisclosed Foreign Asset
If you do not disclose specified foreign assets on Form 8938, you may owe a 40% penalty. The penalty is based on any underpayment resulting from the nondisclosure.
Claiming a Basis of Property in Excess of the Amount Reported on an Estate Tax Return
Executors filing estate tax returns must provide to heirs the value of the property they inherit. This information is on Schedule A of Form 8971. The value reported to them (and the IRS) becomes their tax basis. If they use a higher basis when they sell or otherwise dispose of the property, they face a basic 20% penalty.
Preparer Penalties
If you are a tax return preparer, you face an array of penalties with respect to your professional duties. Table B.3 shows the penalty amounts for various failures. These are the penalty amounts for 2022 returns filed in 2023.
Penalty Relief
Even if you've incurred penalties, you may be able to get them lifted. In tax parlance, this is called penalty abatement. Generally, penalty relief falls into 4 categories: reasonable cause, penalty exceptions created in the Tax Code, administrative waivers from the IRS, and correction of IRS errors.
Reasonable Cause
Reasonable cause is based on the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise be assessed. Reasonable cause relief is generally granted if you exercised ordinary business care and prudence in determining your tax obligations but nevertheless failed to comply with those obligations. Ordinary business care and prudence requires you to make reasonable effort to determine your tax obligations. In assessing whether you exercised reasonable care, the IRS looks at the reason given, your past compliance history, the time between the event that triggered the noncompliance and subsequent compliance, and whether there were circumstances beyond your control (e.g., serious illness, fire, or storm).
For small partnerships and S corporations (those with 10 or fewer owners), reasonable cause is met automatically if all owners are natural persons (and not nonresident aliens), all owners receive equal allocations of each entity item, and all owners have reported these items on their personal returns.
Ignorance of the law is no excuse.
Whether your reliance on erroneous advice from a CPA or other tax professional constitutes reasonable cause depends on the penalty. Reasonable cause relief is not available for all penalties, but other types of relief may be available.
Waivers in the Tax Code
The law may create a penalty exception upon which you can rely. Examples:
- Postponing filing deadlines by reason of a federally declared natural disaster or for other reasons.
- Relying on the written advice of the IRS, which turns out to be incorrect.
TABLE B.3 Tax Return Preparer Penalties
| Scenario | Daily Penalty | Maximum Penalty |
|---|---|---|
| Failure to furnish copy to taxpayer | $55 | $28,000 |
| Failure to sign return | $55 | $28,000 |
| Failure to furnish identifying number | $55 | $28,000 |
| Failure to retain copy or list | $55 | $28,000 |
| Failure to file correct information returns | $55 per return or item in return | $28,000 |
| Negotiation of check | $560 per check | No limit |
| Failure to be diligent in determining eligibility for refundable credits | $560 | No limit |
There is also an opportunity to avoid penalties for employment taxes when workers you've been treating as independent contractors are reclassified as employees. Section 530 of the Revenue Act of 1978 creates this relief. Find details at https://www.irs.gov/government-entities/worker-reclassification-section-530-relief.
Administrative Waivers
The IRS has created a number of programs that taxpayers can use to avoid penalties. Examples are:
- Employee Plans Compliance Resolution Program (EPCRS) can be utilized to self‐correct errors in qualified retirement plans. See https://www.irs.gov/pub/irs-pdf/i8950.pdf.
- The penalty relief program for Form 5500‐EZ can be used to obtain penalty relief for an overdue return. Information is available at https://www.irs.gov/retirement-plans/penalty-relief-program-for-form-5500-ez-late-filers.
- Underpayments of employment taxes can be self‐corrected without interest (although penalties may apply). The amount of the underpayment must be paid by the time an adjusted return (e.g., Form 941‐X, Adjusted Employer's QUARTERLY Federal Tax Return or Claim for Return) is filed.
- Undue hardship relief for failing to pay taxes on time can be granted by filing Form 1127, Application of Extension of Time for Payment of Tax Due to Undue Hardship.
- For the Voluntary Classification Settlement Program (VCSP) for reclassifying independent contractors as employees, go to https://www.irs.gov/businesses/small-businesses-self-employed/voluntary-classification-settlement-program.
First‐Time Abatement Program
You may be able to escape a penalty under IRS's first‐time abatement (FTA) penalty waiver program. To qualify, you must have done things right in the past 3 years and be otherwise in compliance with all filings and payment requirements. Find details at https://www.irs.gov/irm/part20/irm_20-001-001r-cont01.html (see 20.1.1.3.3.2.1 in Part 20).