A tax penalty is a charge the Internal Revenue Code adds to a taxpayer’s liability when a filing, payment or accuracy requirement is missed. The Code uses three names for the family, additions to the tax, additional amounts and penalties, and it collects all three the same way it collects the tax itself.
The framing sentence sits in chapter 68. Except as otherwise provided in this title, the additions to the tax, additional amounts, and penalties provided by this chapter shall be paid upon notice and demand and shall be assessed, collected, and paid in the same manner as taxes, and any reference in this title to tax imposed by this title shall be deemed also to refer to the additions to the tax, additional amounts, and penalties provided by this chapter (26 U.S.C. 6665(a)). A penalty is therefore not a fine standing beside the tax. For assessment and collection it is treated as tax.
A Penalty Is Not Interest
Interest is a separate charge with a separate source. If any amount of tax imposed by this title, whether required to be shown on a return, or to be paid by stamp or by some other method, is not paid on or before the last date prescribed for payment, interest on such amount at the underpayment rate established under section 6621 shall be paid for the period from such last date to the date paid (26 U.S.C. 6601(a)).
Interest then runs on the penalties too, and when it starts depends on which penalty. It is imposed on any assessable penalty, additional amount, or addition to the tax, other than an addition to tax imposed under section 6651(a)(1) or 6653 or under part II of subchapter A of chapter 68, only if that amount is not paid within 21 calendar days from the date of notice and demand, 10 business days where the amount equals or exceeds $100,000, and in that case only for the period from the date of the notice and demand to the date of payment (26 U.S.C. 6601(e)(2)(A)). Three classes are on the other timetable, and the clock on them starts much earlier. For any addition to tax imposed by section 6651(a)(1) or 6653 or under part II of subchapter A of chapter 68, interest runs for the period which begins on the date on which the return of the tax with respect to which such addition to tax is imposed is required to be filed, including any extensions, and ends on the date of payment of such addition to tax (26 U.S.C. 6601(e)(2)(B)).
The Accuracy-Related Penalty
This is the charge that attaches to the return being wrong rather than late. If this section applies to any portion of an underpayment of tax required to be shown on a return, there shall be added to the tax an amount equal to 20 percent of the portion of the underpayment to which this section applies (26 U.S.C. 6662(a)).
It reaches only the portion of an underpayment attributable to one or more of a listed set of causes, and the first two are the ones a preparer meets most: negligence or disregard of rules or regulations, and any substantial understatement of income tax (26 U.S.C. 6662(b)). The subsection runs to ten numbered paragraphs in all, continuing into valuation misstatements, substantial overstatements of pension liabilities, transactions lacking economic substance, undisclosed foreign financial asset understatements and inconsistent estate basis (26 U.S.C. 6662(b)).
Negligence carries a statutory meaning here, and it is wider than carelessness. For purposes of this section, the term negligence includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term disregard includes any careless, reckless, or intentional disregard (26 U.S.C. 6662(c)).
Substantial understatement is arithmetic, and it is a greater-of test with two limbs. For purposes of this section, there is a substantial understatement of income tax for any taxable year if the amount of the understatement for the taxable year exceeds the greater of 10 percent of the tax required to be shown on the return for the taxable year, or $5,000 (26 U.S.C. 6662(d)(1)(A)). One class of taxpayer is measured on a tighter version of the same test: in the case of any taxpayer who claims any deduction allowed under section 199A for the taxable year, subparagraph (A) shall be applied by substituting 5 percent for 10 percent (26 U.S.C. 6662(d)(1)(C)). A corporation other than an S corporation or a personal holding company as defined in section 542 is measured on a lesser-of test instead, comparing 10 percent of the tax required to be shown on the return, or if greater $10,000, against $10,000,000 (26 U.S.C. 6662(d)(1)(B)).
Reasonable Cause Is Written Into the Statute
It is a defence the Code provides, not a concession the examiner makes. No penalty shall be imposed under section 6662 or 6663 with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion (26 U.S.C. 6664(c)(1)). Carve-outs sit immediately under it. Paragraph (1) shall not apply to any portion of an underpayment which is attributable to one or more transactions described in section 6662(b)(6) or to any disallowance of a deduction described in section 6662(b)(10) (26 U.S.C. 6664(c)(2)). A further rule switches the defence off for an underpayment attributable to a substantial or gross valuation overstatement under chapter 1 with respect to charitable deduction property, and then switches it back on for a substantial valuation overstatement where the claimed value was based on a qualified appraisal made by a qualified appraiser and the taxpayer also made a good faith investigation of the value of the contributed property (26 U.S.C. 6664(c)(3)).
The two late additions carry their own version of the test, written into the operative sentence rather than into a separate subsection. Each of the three paragraphs imposing them applies unless it is shown that such failure is due to reasonable cause and not due to willful neglect (26 U.S.C. 6651(a)).
The Estimated Tax Charge Is Priced Like Interest, Not Like a Percentage
The individual estimated tax addition is not a flat rate on a balance. Except as otherwise provided in this section, in the case of any underpayment of estimated tax by an individual, there shall be added to the tax under chapter 1, the tax under chapter 2, and the tax under chapter 2A for the taxable year an amount determined by applying the underpayment rate established under section 6621, to the amount of the underpayment, for the period of the underpayment (26 U.S.C. 6654(a)).
Two exceptions switch it off. No addition to tax shall be imposed under subsection (a) for any taxable year if the tax shown on the return for such taxable year, or, if no return is filed, the tax, reduced by the credit allowable under section 31, is less than $1,000 (26 U.S.C. 6654(e)(1)). The prior-year exception has three conditions and every one of them has to hold: the preceding taxable year was a taxable year of 12 months, the individual did not have any liability for tax for the preceding taxable year, and the individual was a citizen or resident of the United States throughout the preceding taxable year (26 U.S.C. 6654(e)(2)). Which line on the prior-year return answers the middle condition is set out in tax liability.
Some Penalties Need a Supervisor’s Signature and Some Do Not
There is a procedural rule that decides whether a human ever looked at the charge. No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved, in writing, by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate (26 U.S.C. 6751(b)(1)).
The exception is the half worth knowing, and it is quoted here with its parenthetical in place because the parenthetical is doing the work. Paragraph (1) shall not apply to any addition to tax under section 6651, 6654, 6655, or 6662 (but only with respect to an addition to tax by reason of paragraph (9) or (10) of subsection (b) thereof), or to any other penalty automatically calculated through electronic means (26 U.S.C. 6751(b)(2)). The same section also settles the vocabulary: for purposes of this section, the term penalty includes any addition to tax or any additional amount (26 U.S.C. 6751(c)).
The Two Late Charges Are Covered Separately
Failure to file and failure to pay are the additions that reach the most returns, and both are worked through elsewhere rather than restated here. The rates, the minimum charge on a badly late return and the per-partner basis a partnership is charged on are priced out in finance and accounting BPO. How the two interact around the extended October filing date, including the written reasonable cause showing and the reduced rate that applies while an installment agreement is in effect, is in the extended October filing deadline.
Where a penalty stops being civil and becomes an allegation of fraud is a different question, drawn in tax evasion vs fraud, and the line between lawful planning and evasion is in tax avoidance vs evasion.
Common Questions
A penalty is a charge for conduct: filing late, paying late, or getting the return wrong. Interest is a charge for time, imposed at the underpayment rate established under section 6621 for the period from the last date prescribed for payment to the date paid (26 U.S.C. 6601(a)). Interest then runs on the penalties as well, on the timetable that paragraph sets, which is why a single notice can show both (26 U.S.C. 6601(e)(2)).
For the accuracy-related and fraud penalties the Code names the ground: no penalty shall be imposed under section 6662 or 6663 with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion (26 U.S.C. 6664(c)(1)). For the estimated tax addition the ground is different, and there are two of them. No addition to tax shall be imposed under subsection (a) with respect to any underpayment to the extent the Secretary determines that by reason of casualty, disaster, or other unusual circumstances the imposition of such addition to tax would be against equity and good conscience (26 U.S.C. 6654(e)(3)(A)). A separate waiver runs for newly retired or disabled individuals on determinations the same paragraph sets out (26 U.S.C. 6654(e)(3)(B)).
Some are. The written supervisory approval requirement carries an exception that names a set of additions to tax and then extends to any other penalty automatically calculated through electronic means (26 U.S.C. 6751(b)(2)). A late filing charge can therefore appear on a notice without any individual officer having determined it.
Accountably places offshore accountants and tax preparers inside US CPA and EA firms, working in the firm’s own systems and under the firm’s own review. Where late filings and late payments trace back to capacity rather than to judgment, adding reviewed preparation and bookkeeping hours is the part of the problem a staffing model can actually solve.
