Tax Penalties 101

Avoid These Simple Tax Return Mistakes

Tax Penalties 101
April 12, 2018

The Internal Revenue Service has plenty of ways to penalize you for mistakes on your tax return. Some of these potential penalties are so convoluted and complex that there may well be disagreement within the IRS on when they apply. However, most people accrue tax penalties for very simple mistakes. Here are some of the more common yet easily avoidable mistakes.

  • Failing to File – Do you really think the IRS will forget about the fact that you did not file your tax return? It may take some time, but the IRS will eventually catch up with you. Expect little sympathy if you do not file. The IRS is willing to work with people to make payments, but if you make no effort at all, you are subject to the non-filing penalties of 5% per month of the due taxes, up to 25% of your unpaid tax bill.

    Many people simply put off filing until it is too late, and think that doing nothing is better than attempting to file a potentially wrong return. You can deal with that problem by filing an extension with Form 4868 to buy time. Note that 4868 does not buy you time to pay, just time to file. You still must make a reasonable estimate of your expected tax payments.

    Of course, the best solution to the problem is to keep your records organized throughout the year to make the April filing easier.

  • Not Making Payments – If you do not pay the taxes that you owe by April 17th (normally April 15th), another penalty applies, just not as large of a penalty as for non-filing. The monthly penalty is 0.5% of your unpaid taxes, up to 25% total. That applies even with an extension, since Form 4868 requires you to estimate your taxes and send in your payment with the form. "Filing for an extension doesn't get you an extension to pay," warns Betterment Head of Tax Eric Bronnenkant. "Let's say you don't pay by April 17th, well then you're still going to have to pay interest on that money later anyway. Filing for an extension is typically a good idea if, let's say, you haven't gotten all your tax documents, you've been working overseas and you didn't get all the information you needed from your employer, or you've got a complex tax return and you're investing in complex investments. Those are good reasons to request an extension. Requesting an extension doesn't solve any problems, if your only problem is that you expect to owe money."

    The IRS does allow installment programs and other provisions in some cases that can reduce or eliminate penalties and interest, so it really is in your best interest to explore options rather than to send in partial payments on your own (or avoid payment altogether).
  • Forgetting Signatures – If you fail to sign your paper form, it is as if it was never submitted. That is even true with e-forms, where you "sign" via a PIN number. Double-check to make sure that you sign your form. Otherwise, you will be subject to the non-filing penalties unless you send in a properly signed form as well — but you risk IRS confusion with two submitted forms.

  • Not Making Quarterly Payments – Self-employed individuals must make quarterly estimated tax payments throughout the year so the government can receive regular cash flow from estimated taxes in the same way that employers take out monthly deductions for taxes. Filing in a lump sum at the end of the year can result in an "underpayment" penalty even if you paid the full amount of taxes due. You did not pay it at the right time.

    You can avoid this penalty by making sure estimated taxes are regularly paid. For independent contracting jobs where the income varies greatly, you can use the "safe harbor" provision by paying 100% of last year's tax liability or 90% of this year's estimate, whichever is less. If you also have a salaried job or your spouse has one and you file jointly, you can cover the taxes by having extra monthly taxes withheld on the salaried position. That spreads the taxes out in roughly the right time period.

  • No Apparent Health Insurance – The Affordable Care Act requires that you have health insurance or you must pay a penalty (for 2017) of the greater of 2.5% of your income, or $695 per each adult not covered, plus $347.50 per child not covered. Each 1040-style form has a box to check for "Health care: individual responsibility." Fail to check this box and the IRS has no way to know that you have health insurance; thus, you will be assessed a penalty. The individual insurance mandate was abolished in the Tax Cuts and Jobs Act of 2017; however, this change doesn't take effect until 2019.

With a little attention and vigilance, you can reduce your chances of simple errors that could result in tax penalties and/or audits. Why give the IRS any more of your money than you have to?

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