The High Cost of Noncompliance
by Kimberlee S. Phelan, CPA, MBA, Tax Partner;
Congressional aversion to raising taxes in today’s continuing difficult economy is abundantly clear. The Internal Revenue Service (IRS) is left in the position of trying to increase revenue for a government badly in need of funding without a corresponding increase in tax rates. If you think the IRS has it bad, pressure is even higher on the 7,645 state and local tax authorities.
What does this mean for taxpayers? The IRS and state and local tax authorities have begun an outright assault to increase revenue through the imposition of PENALTIES. Most of the penalties have been “on the books” for a very long time but have been assessed only in egregious situations. These days, any and every penalty that can be assessed will be assessed — and obtaining abatement of those penalties, even for “reasonable cause,” can be an extremely frustrating and time-consuming activity. You can avoid the imposition of penalties by being reasonable and transparent in your tax positions, while also being diligent, prepared and not delinquent.
While this summary will focus on monetary penalties, bear in mind that penalties imposed by the IRS may also include forfeiture of property and even jail time!
Late Filing Penalty
5% per month, up to 25%, of the tax due (if more than 60 days late, a minimum penalty of $100).
Paying Late Penalty
0.5% per month, up to 25%, of the tax due. This penalty is not assessed during the extension period if 90% of the tax is paid by the original due date.
Estimated Tax Penalties
imposed when withholdings and/or estimated tax payments made throughout the year do not cover 90% of current year (or 110% of the prior year) tax.
Accuracy-Related Penalties
20% of the understatement of tax, when understatement is substantial, due to negligence or due to a disregard of the rules and regulations.
Frivolous Tax Return Penalty
$5,000 for filing a return that does not include enough information to properly figure the correct tax, and the tax reported is substantially incorrect. If a joint returnis filed, the penalty is assessed on both taxpayer and spouse.
Penalty for Bounced Checks
2% of the check (if check is less than $1,250, the penalty is the lesser of $25 or the amount of the check).
Economic Substance Doctrine
20% penalty for an underpayment of tax attributable to a transaction lacking economic substance (increased to 40% if the transaction is not disclosed).
Failure to Disclose Reportable or Listed Transaction
a minimum of $50,000 for each failure!
The bottom line regarding your income taxes is that you should: 1) report all of your income appropriately, 2) file your return on time and 3) pay your tax on time in order to avoid the imposition of penalties. Note: the penalties detailed above are calculated separately and do not offset —they accumulate.
The penalties for failure to furnish and/or the late filing of information reports (Forms 1099 and W-2) are small ($15 to $50), but are assessed on a per form basis. These small amounts can add up quickly; missing the filing deadline for 100 forms will result in a minimum penalty of $1,500.
The penalties are quite severe for “responsible persons” who willfully fail to deposit taxes such as payroll taxes. The tax withheld on behalf of employees is not the employer’s money —it belongs to the employee, and the penalty for failure to pay-over these amounts in a timely manner is up to 100% of the tax. Additionally, this tax and penalty can be assessed not only on the employer (i.e., a business entity), but become personal liabilities of the responsible person and are not discharged in bankruptcy.
The President, Congress and the IRS have openly stated that the biggest opportunity for increasing the government coffers is through the strict application of U.S. tax law to the international operations of U.S. taxpayers. The IRS recently implemented programs in 2009 and 2011 to bring U.S. taxpayers into compliance through the Offshore Voluntary Disclosure Initiatives. The 2009 initiative was planned to have 7,000 taxpayers disclose their foreign bank accounts; over 14,000 taxpayers came forward. A second initiative closed this past September and was billed as the “last best chance” for U.S. taxpayers to avoid excessive penalties and jail time for nondisclosure of foreign bank accounts.
The penalties related to noncompliance with foreign disclosure requirements begin at $10,000 per form not filed. These forms do not necessarily result in additional U.S. taxable income or income tax, but are required to report foreign transactions and activities such as ownership of a foreign subsidiary, a foreign partnership, a foreign disregarded entity, or (beginning with 2011 tax returns) a foreign financial asset. Penalties are also imposed for failure to report transactions with related entities if the U.S. entity’s ownership is more than 25% foreign. In addition to the $10,000 per form penalty, failure to file disclosure forms may also result in the loss of foreign tax credits, which could reduce a U.S. taxpayer’s federal tax due.
Unreported transfers to foreign corporations can result in a penalty of 10% of the value of the transfer up to $100,000 and failure to furnish information related to foreign trusts or gifts can result in a penalty of up to 35% of the fair market value of trust assets or the foreign gift. Penalties also apply for non-reporting of treaty-based positions as well as transacting business with a list of “boycott” countries. Finally, the Treasury Regulations require that transactions with related parties should be undertaken on an “arm’s length basis.” Should the IRS determine that an appropriate “transfer price” was not utilized, or that proper documentation of that transfer price was not maintained, the penalty is 20% to 40% of the understatement of tax based upon using the incorrect transfer price.
Tax evasion, willful failure to file a return, filing of a false return and fraud all carry the threat of criminal prosecution in addition to monetary penalties —and the list above is by no means all-inclusive. What’s a taxpayer to do? Be reasonable; be diligent (and not delinquent); and be prepared. The best defense is not only a good offense, but common sense, along with a clear understanding of the rules and regulations, appropriate disclosure of transactions, and timely filing of all returns and payment of all taxes.
© 2011 WithumSmith+Brown, PC
Kimberlee S. Phelan, CPA, MBA, Tax Partner
Based in our Princeton office, Kimberlee is a tax partner with over 15 years of accounting and tax experience. Kimberlee’s expertise lies in federal, state and local tax issues affecting corporations, partnerships and individuals. She concentrates her efforts on special projects such as corporate tax research and planning, inbound and outbound international structuring, individual tax and executive compensation planning.