July 25, 2017

10 Tax Penalties – and How to Avoid Them


Tips on Avoiding Tax Penalties for Your Small Business

As if taxes weren’t enough, the IRS can add interest and penalties for certain action you may take or fail to take. There are over 150 civil penalties in the Internal Revenue Code. Tax penalties can be costly and they’re not tax deductible. Here is a roundup of some tax penalties that can impact small businesses owners and what can be done to avoid them.

Tips on Avoiding Tax Penalties for Your Small Business

1. Late Filing Penalty for Tax Returns

April 15 may be seared into your brain as tax day, but it’s not the deadline for all returns. S corporations and partnerships (including limited liability companies filing as partnerships) have a March 15 deadline. If you’re late on your personal return, the penalty is 5 percent of what’s owned for each month you’re late (up to 25 percent). If the return is more than 60 days late, there’s a minimum penalty of the smaller of 100 percent of the tax due or a dollar amount ($210 for 2017 returns to be filed in 2018). For S corporations and partnerships, the penalty is a dollar amount per-owner per-month penalty. For 2017 returns filed in 2018, the penalty will be $200 per-owner each month (or part of a month).

What to do: Check the deadline for your return, which happily may be later than you expect because of weekends and holidays. If, for any reason you can’t meet the deadline, ask for a filing extension by the deadline.

2. Estimated Tax Penalty

If you underpay your income taxes, you may be subject to a penalty. This penalty is effectively an interest charge based on the IRS rate, which can be adjusted quarterly. Currently, it’s 4 percennt.

What to do: Recheck estimates each time you make installments and review estimated tax safe harbors. For example, if you peg your 2017 estimated taxes at 100 percent of your 2016 tax liability (or 110 percent of it if you’re a high income taxpayer), you won’t owe any penalty no matter how short you fall.

3. W-2 Mistakes

If you fail to file Form W-2 for each employee, or you make a mistake and don’t correct it (other than a de minimis one), you’ll be penalized. The later you are in submitting the form, the higher the penalty. As long as you filed the W-2 for 2016 within 30 days of the deadline, the late-filing penalty is $50 per form. If you file after 30 days, but through August 1, 2017, the penalty doubles to $100 per form. But if you don’t file until after August 1, 2017, the penalty jumps to $260 per form.

What to do: Furnishing employees with their W-2s and sending transmittals to the Social Security Administration is a priority action for employers. Mark your calendars for next year: W-2s for 2017 compensation are due on January 31, 2018.



4. 1099 Mistakes

If you fail to file a required Form 1099, such as a 1099-MISC for independent contractors to whom you paid at least $600, your tardiness will cost you. Again, the later you are in submitting the form, the higher the penalty. The same penalties for late W-2s apply for late 1099s.

What to do: Watch the specific deadline for a 1099 you are required to file because there are different deadlines for different types of 1099s.

5. Trust Fund Penalty

As an employer you are required to deposit withholding from employees’ compensation with the U.S. Treasury. If you don’t, you may be held 100 percent personally liable for the funds you failed to deposit. This is referred to as a trust fund penalty.

What to do: Verify that required deposits have been made. If you use an outside payroll company, don’t assume deposits have been made; check on this.

6. Accuracy-related Penalties

The burden on taxpayers is to submit tax returns that truly reflect income and expenses. If an underpayment is substantial (for individuals it means the greater of $5,000 or 10 percent of the tax that must be shown on the return; for C corporations it’s higher) and results from negligence or disregard for the rules and regulations, there’s a 20 percent penalty on the underpayment.

What do to: Businesses must keep good books and records (it’s difficult to avoid a penalty without them). Also, get good tax advice. Reliance on a tax professional may help to avoid a penalty in the right circumstances.

7. Excess Contribution Penalty

If you have a qualified retirement plan or IRA and add more than the law allows, you may be subject to a 6 percent excess contribution penalty. This penalty continues to apply each year until the excess is corrected.

What to do: Carefully calculate annual contributions. If you find that you’ve made an error, withdraw promptly to avoid or minimize the penalty.

8. Early Distribution Penalty

Another action related to a qualified retirement plan or IRA is tapping into it too early. There’s a 10 percent penalty that usually applies for distributions prior to age 59½.

What to do: If you need funds prior to this age, try to find them elsewhere. If you must use retirement savings early, see whether a penalty exception applies (e.g., using IRA funds to pay for higher education). Penalty exceptions are listed in IRS Publication 590-B.

9. Non-medical Distribution Penalty

If a distribution is taken from a health savings account to pay for nonmedical expenses, there’s a 20 percent penalty.

What to do: Restrict distributions to qualified medical expenses (they’re listed in IRS Publication 969). Or wait until after attaining age 65, when the penalty for nonmedical distributions no longer applies.

10. Health Mandates

The Affordable Care Act imposes penalties on individuals who fail to carry health coverage (unless exempt) and on large employers that don’t provide their full-time employees with coverage. These penalties, however, may be waived or eliminated by new legislation.

What to do: Watch developments in Congress for the American Health Care Act.

Conclusion

These are only a select few of the many penalties that tax missteps can trigger. And these are only some of the actions available to minimize or avoid penalties. For example, you may escape some by showing reasonable cause or others by claiming a first-time abatement option. Understand your responsibilities and mark your calendar for key deadlines. Work with a knowledgeable tax advisor to make sure you stay compliant. 

Tax Law Folder Photo via Shutterstock

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Barbara Weltman


Barbara Weltman Barbara Weltman is the Tax Columnist for Small Business Trends. She is an attorney and author of J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and is a trusted professional advocate for small businesses and entrepreneurs.

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