IRS penalties are no joke. They can make credit card late charges and interest look tame. The two biggies for individual tax filers are the 50% excise tax on required minimum distributions that were not taken on time from retirement accounts, and the penalties for filing a tax return late and paying the tax due late.
When you file your tax return late without a valid extension, the IRS assesses a 5% penalty on the tax due for every month or part of a month it is late, up to 25%. And for the unpaid tax, there is a penalty of .5% per month or part of a month, also up to 25%. If both the late filing and late payment penalties apply in any given month though, the late payment penalty is waived. Oh and there’s interest assessed too, not only on the tax due but on the penalties as well.
If you file late and are due a refund, no harm no foul, 25% of $0 is $0. You have three years from the date the original return was filed to claim that refund, and they’ll even pay YOU interest. Go past the three years and you can’t get any refund back, but if you owe them you still have to pay.
However a well kept secret by the IRS can give you relief if you’ve been a good taxpayer up until that point or can get yourself in shape quickly. It’s called the First Time Abatement and it can eliminate the late filing and late payment penalties and their associated interest for one single tax year. In order to take advantage of the FTA program, you must be in compliance and have all of your required returns filed and paid (or arranged to pay the tax due) and have not had any significant penalties assessed in the prior three years.
There are a few ways to request a FTA; the easiest is to call the IRS and ask, although the limit allowed to be abated by phone is rumored to be $1,000 (the IRS doesn’t publish the real figure). You can also request an abatement in writing, or head off the penalties completely by including a request for abatement in advance when you’re filing your late return. And if you only just now heard of the program and realized you paid penalties in the past that could have been abated, you can submit a form 843 to request a refund. There are other remedies for penalty relief available, reasonable cause for example, but none are as “automatic” as the FTA. It is quite common for someone who has not filed taxes for one year to also have numerous years of unfiled returns. In that case, if there are other grounds for penalty abatement for some tax years, it’s best to leave the FTA for a year where you owe the most penalties and interest and where there is no other cause to grant abatement.
For seniors who forget to take a required minimum distribution from a retirement account for the first time, avoiding the 50% excise tax is as simple as filing form 5329 with the tax return when filed, explaining the reasonable cause for why the distribution was not taken (illness, financial advisor error, death in the family, serving time in jail). Hopefully you’ll never hear a word about it from the IRS, because no news is good news here.
The IRS uses an automated system to evaluate whether a penalty abatement should be granted and they are often wrong (shocking but true). So it pays to hire a tax practitioner like an Enrolled Agent to help sort it out and get all the penalty relief to which you are entitled- good representation can save you a bundle.