Explanation of IRS Penalties
There is a lot of confusion centered on IRS assessed penalties. Recently quite a few clients have insisted we file their S-Corp or LLC tax returns by March 15th or April 15th (due date before extensions) because they do not want to extend and get penalized. An extension on a pass through entity does not result in any penalties. The non-payment of tax owed on the personal return is what causes penalties.
If your personal tax information is not ready prematurely filing your S-Corp or LLC returns without evaluating the whole situation will only make matters worse. A lot of times clients will submit items with their personal information that really should have been submitted with their business and vice versa. While other CPAs and Tax Accountants may differ I find it is best to look at my clients taxes all at once (both business returns and personal returns). This helps me not only to minimize the current tax liability but also with future planning.
I have provided a summary of the various applicable penalties.
Filing late - not filing your return by the due date (including extensions). If you are receiving a refund on a personal or C-Corporation return there are no late filing penalties since the penalty is based on the amount due. If you owe taxes the penalty is 5% for each month or part of a month up to a maximum of 25% of the amount due. For pass through entities (S-Corporations and LLCs) the penalty is $195 for each month or part month times the number of partners or shareholders. OUCH thats steep!! The lesson here is to not file late. If you can't get your taxes in by the due date (March 15th for Corporations including Sub-chapter S corporations or April 15th for personal and LLCs an extension must be filed). As long as an extension is filed and the return is filed by the extension date no penalties will be assessed. In the past we have had problems with the IRS assessing late filing penalties on returns that were filed with extensions. We do not know what causes this but we do have an electronic postmark when extensions are filed. Supplying this document to the IRS will remove the penalty. Whenever you get a letter from any tax agencies on returns that Profound has prepared we are happy to assist but can only do so if you communicate with us. We do not get copies of these notices.
Estimated tax penalty - taxes are due as you earn the money not by April 15th. If you are not in a situation where income tax can be withheld from a pay check you must make estimated tax payments. The amount that must have been paid in by Jan 15th (the due date for 4th quarter estimated payments) is either 90% of the current year tax or 100% of the prior year tax whichever is smaller. It must be paid in 4 equal instalments during the year. If your income is uneven or received in the latter part of the year we can fill out a form to reduce the penalty. The estimated tax penalty is calculated up to the date the return is filed or through March 15th for corporations or April 15th for individuals. After these dates it becomes a late payment penalty. This penalty can be reduced or eliminated by making quarterly payments or increasing your withholding.
Paying late - This is the one that catches everyone and quite a few people mistake this for a late filing and believe that they are being assessed because the return was filed on extension. A failure to pay penalty is assessed because taxes were not paid by March 15th for C-Corporations or by April 15th for individuals. The extension is an extension to file NOT an extension to pay. If you know you haven't made any payments during the year it is imperative that you make an estimate and pay by those dates to avoid or minimize the late payment penalty. If you pay by March 15th or April 15th at least 90% of the tax due you will not be assessed this penalty during the extension period. This will not remove the estimated tax penalty that will be assessed based on not making estimated payments during the year. The penalty amount is .5% of the unpaid tax each month or part of a month that the balance remains unpaid. Unlike the late filing penalty there is no limit on the assessment.
I hope this clarifies some of the penalties that the IRS assesses. Obviously the best way to avoid penalties is to file on time (including extensions) and to make your estimated payments and to check in with us to make sure the estimates are sufficient.
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