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You get an email from your accountant with shocking news. Your LLC's tax return is two months late. You owe $18,000 in taxes. You assumed your accountant filed the extension and would handle everything. He didn't. The IRS assesses a penalty for filing taxes late of $1,800 (5% per month for 2 months since the April 15 deadline). You also owe failure-to-pay penalties of $180 (0.5% per month for 2 months). Combined penalties: $1,980 on an $18,000 tax bill—an 11% penalty surcharge for missing a deadline you didn't know was your responsibility to track.
Your startup failed to file Form 1099s for the contractors you paid $95,000 total. You didn't know businesses must file information returns for payments exceeding $600 per contractor. The IRS assesses penalties of $310 per late Form 1099. With 12 contractors, the penalty totals $3,720 for forms that report zero tax liability—purely informational forms you didn't know existed, far exceeding what typical small business tax evasion penalties would suggest for simple reporting errors.
Business tax penalties can apply when you cannot afford to pay taxes owed, underreporting income or overstating deductions. In this article you'll learn exactly how failure-to-file and failure-to-pay penalties are calculated and combined, when the 20% accuracy-related penalty applies and how to avoid it. We also cover how estimated tax penalties work and the safe harbor rules to prevent them, what reasonable cause and IRS first time penalty abatement are and how to qualify.
What is failure-to-file penalty?
The failure-to-file penalty is assessed when you don't file your tax return by the due date including extensions, creating a significant penalty for filing taxes late.
How the penalty is calculated
The penalty is 5% of the unpaid tax for each month (or part of a month) the return is late, up to a maximum of 25% of the unpaid tax.
Exception: S-Corporations and Partnerships
S-corporations (Form 1120-S) and partnerships (Form 1065) are subject to a separate late-filing penalty structure that applies even if no tax is owed.?
Penalty: $245 per shareholder (S-corp) or per partner (partnership) per month, up to 12 months.?
Formula: $245 × number of shareholders/partners × months late (maximum 12 months)
Example: Your S-corporation has 3 shareholders and files 4 months late. The return shows $0 tax due (all income passed through to shareholders).
Failure-to-file penalty: $245 × 3 shareholders × 4 months = $2,940
Even with zero tax liability, the penalty is $2,940.?
Minimum penalty when filed more than 60 days late
If you file more than 60 days late, there's a minimum penalty for filing taxes late of the lesser of $525 (for 2025 returns filed in 2026) or 100% of the unpaid tax.
Example: You owe $200 in taxes and file 65 days late. The standard penalty would be $200 × 5% × 3 months = $30. But the minimum penalty is $200 (100% of tax), so you owe $200 in penalty on a $200 tax bill—doubling your liability.
Extensions eliminate failure-to-file penalty
Filing Form 7004 (for business returns) or Form 4868 (for individual returns) by the original due date extends the filing deadline by 6 months and eliminates the penalty for filing taxes late if you file by the extended deadline.
Critical point: Extensions extend the time to file, not the time to pay. You must pay at least 90% of your tax liability by the original due date to avoid failure-to-pay penalties, even with a valid extension.
Penalty applies only to unpaid tax
If you file late but owe no tax (or have a refund coming), there's no penalty for filing taxes late. The penalty is based on unpaid tax at the time of filing.
Example: You file your C-corporation return 4 months late. The return shows $0 tax due (losses for the year). Failure-to-file penalty: $0 (no unpaid tax to penalize).
Failure-to-pay penalty: 0.5% per month
The failure-to-pay penalty is assessed when you don't pay taxes owed by the due date.
How the penalty is calculated
The penalty is 0.5% of the unpaid tax for each month (or part of a month) the tax remains unpaid.
Unlike the penalty for filing taxes late (capped at 25% after 5 months), the failure-to-pay penalty can continue for up to 50 months, reaching a maximum of 25% of the unpaid tax.
Formula: Unpaid tax × 0.5% × number of months unpaid (maximum 50 months)
Example calculation
You owe $50,000 in taxes. You file on time but can't pay. You can use a tax penalty calculator to estimate:
- After 12 months unpaid: $50,000 × 0.5% × 12 = $3,000 in failure-to-pay penalties
- After 24 months unpaid: $50,000 × 0.5% × 24 = $6,000 in failure-to-pay penalties
- After 50 months (maximum): $50,000 × 0.5% × 50 = $12,500 (25% cap reached)
Penalty increases to 1% after IRS notice
If the IRS issues a notice of intent to levy and you still don't pay, the failure-to-pay penalty increases from 0.5% to 1% per month for months after the notice.
Extensions don't eliminate failure-to-pay penalties
Filing an extension gives you more time to file but doesn't extend the payment deadline. You must pay at least 90% of your tax liability by the original due date (April 15 for most businesses filing as individuals, March 15 for S-corporations and partnerships) to avoid failure-to-pay penalties.
Payment plans reduce the penalty rate
If you enter into an IRS installment agreement to pay your tax over time through business tax services, the failure-to-pay penalty is reduced to 0.25% per month (half the normal rate) during the period the agreement is in effect and you're making required payments.
Combined failure-to-file and failure-to-pay penalties
When you both file late and pay late, both penalties can apply—but they're coordinated to avoid double-penalizing, which any tax penalty calculator must account for.
Combined penalty calculation
For months when both penalties apply, the penalty for filing taxes late is reduced by the amount of the failure-to-pay penalty. The combined penalty is 5% per month for the first 5 months (4.5% failure-to-file + 0.5% failure-to-pay).
After 5 months, the failure-to-file penalty maxes out, and only the 0.5% per month failure-to-pay penalty continues.
Example: Filing 8 months late and not paying
You owe $40,000. You file 8 months late and still haven't paid.
Months 1-5: Combined penalty = 5% per month
- $40,000 × 5% × 5 months = $10,000
Months 6-8: Only failure-to-pay penalty applies (failure-to-file maxed out)
- $40,000 × 0.5% × 3 months = $600
Total penalties: $10,600
Plus interest: Interest compounds daily on both the unpaid tax and the penalties (currently around 8% annually as of 2025)
Filing eliminates the 5% monthly penalty even if you can't pay
The penalty for filing taxes late (5% per month) is much more expensive than the failure-to-pay penalty (0.5% per month). Always file your return on time (or on extension) even if you can't pay. This reduces your monthly penalty from 5% to 0.5%—a 90% reduction.
Accuracy-related penalty: 20% of underpayment
The accuracy-related penalty applies when you understate your tax liability on a filed return, creating issues beyond typical small business tax evasion penalties.
When the penalty applies
The 20% accuracy-related penalty is assessed for:
- Negligence or disregard of rules and regulations: Failure to make a reasonable attempt to comply with tax laws, or careless, reckless, or intentional disregard of rules.
- Substantial understatement of income tax: The understatement exceeds the greater of 10% of the correct tax or $5,000 ($10,000 for corporations other than S-corps).
- Substantial valuation misstatement: Claiming the value of property is 150% or more (but less than 200%) of the correct value, or 65% or less (but more than 50%) for estate/gift tax. Penalty: 20% of underpayment.
- Gross valuation misstatement: Claiming the value of property is 200% or more of the correct value, or 50% or less for estate/gift tax. Penalty: 40% of underpayment.
- Substantial overstatement of pension liabilities: Overstating pension liabilities by 200% or more.
- Substantial estate or gift tax valuation understatement: Undervaluing estate or gift property by 65% or less of correct value.
How the penalty is calculated
The penalty is 20% of the portion of underpayment attributable to the accuracy-related issue.
Formula: Underpayment amount × 20%
Example: Substantial understatement
Your Schedule C shows $80,000 net profit. After the audit, the IRS determines you underreported income, and your actual net profit was $120,000. The additional $40,000 increases your tax by $14,000.
Substantial understatement test: Is $14,000 > 10% of correct tax?
- Your correct tax was approximately $35,000
- 10% of $35,000 = $3,500
- $14,000 > $3,500, so this is a substantial understatement
Accuracy-related penalty: $14,000 × 20% = $2,800
You now owe the additional $14,000 in tax, plus $2,800 penalty, plus interest—far exceeding simple small business tax evasion penalties for reporting errors.
Reasonable cause exception
The accuracy-related penalty doesn't apply if you can show reasonable cause for the understatement and that you acted in good faith.
Reasonable cause includes:
- Relying on professional tax advice from a qualified advisor through business tax services
- Complexity of the tax law in your specific situation
- Good faith misunderstanding of facts or law
Disclosure reduces penalty exposure
If you disclose uncertain tax positions on Form 8275 (Disclosure Statement) or Form 8275-R (Regulation Disclosure Statement), you may avoid the negligence portion of the accuracy-related penalty (but not the substantial understatement portion unless you have substantial authority for the position).
No stacking of accuracy penalties
If multiple accuracy-related grounds apply (negligence AND substantial understatement), you don't get penalized twice—the maximum accuracy-related penalty is 20% of the underpayment.
Estimated tax penalties
Businesses and self-employed individuals must pay estimated taxes quarterly. Failing to pay enough estimated tax triggers underpayment penalties even if you pay the full amount when filing your return.
Who must pay estimated taxes
You must pay estimated taxes if you expect to owe at least $1,000 in tax after withholding and credits.
This includes:
- Self-employed individuals (Schedule C income)
- S-corporation shareholders receiving distributions
- Partners in partnerships
- Anyone with significant income not subject to withholding
Quarterly estimated tax deadlines
Estimated taxes are due quarterly:
- Q1 (Jan 1 - Mar 31): Due April 15
- Q2 (Apr 1 - May 31): Due June 15
- Q3 (Jun 1 - Aug 31): Due September 15
- Q4 (Sep 1 - Dec 31): Due January 15 of following year
Safe harbor rules to avoid penalties
You can avoid estimated tax penalties if you meet either safe harbor:
Safe Harbor 1: Pay at least 90% of current year's tax liability through estimated payments and withholding.
Safe Harbor 2: Pay at least 100% of prior year's tax liability (110% if prior year AGI exceeded $150,000).
Example: Safe harbor prevents penalty
Your 2024 tax liability was $40,000. Your 2025 tax liability is $65,000.
You made quarterly estimated payments of $10,000 each ($40,000 total) based on your 2024 tax.
When you file your 2025 return, you owe an additional $25,000. But because you paid 100% of your prior year tax liability, you avoid estimated tax penalties even though you underpaid current year by $25,000.
How estimated tax penalties are calculated
The penalty is calculated using IRS Form 2210 based on the underpayment amount and the number of days the payment was late. The penalty rate is approximately the federal short-term rate plus 3% (around 8% currently), calculated daily. A tax penalty calculator can help estimate this.
Estimated tax penalties are not deductible
Unlike interest on business loans, estimated tax penalties are not deductible business expenses.
Information return penalties
Businesses must file various information returns (Forms 1099, W-2, 1095, etc.) by specific deadlines. Late or missing information returns trigger penalties.
Forms subject to information return penalties
- Form 1099-MISC, 1099-NEC (payments to contractors/non-employees)
- Form 1099-K (payment card and third-party network transactions)
- Form W-2 (wages paid to employees)
- Form 1095-B, 1095-C (health insurance coverage)
- Form 1042-S (foreign person's U.S. source income)
Penalty amounts based on how late you file
The following penalty amounts apply to information returns required to be filed in 2025. These amounts are indexed annually for inflation and are subject to adjustment by the IRS each year.
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- Filed within 30 days of due date: $60 per form (maximum $630,000 per year; $220,500 for small businesses)
- Filed more than 30 days late but by August 1: $130 per form (maximum $1,596,500 per year; $566,500 for small businesses)
- Filed after August 1 or not filed: $310 per form (maximum $3,783,000 per year; $1,330,500 for small businesses)
- Intentional disregard: $630 per form with no maximum cap
Example: Late Form 1099-NEC penalties
Your business paid 15 contractors more than $600 each. You were required to file Form 1099-NEC by January 31 but didn't file until March 15 (45 days late).
Penalty: $130 per form × 15 forms = $1,950
If you never filed: $310 per form × 15 forms = $4,650
Small business exception
Small businesses (average annual gross receipts of $5 million or less for the 3 most recent tax years) have lower maximum penalties but the same per-form amounts.
Penalty relief: Reasonable cause
The IRS may abate (remove) penalties if you can show reasonable cause for the failure and that you acted in good faith.
What qualifies as reasonable cause
- Death, serious illness, or unavoidable absence: You or an immediate family member experienced serious illness, death, or unavoidable absence that prevented compliance.
- Fire, casualty, or natural disaster: Your records were destroyed or you were unable to comply due to circumstances beyond your control.
- Unable to obtain records: Despite reasonable efforts, you couldn't obtain necessary records or information.
- Reliance on professional advice: You relied on incorrect advice from a qualified tax professional through business tax services (CPA, attorney, enrolled agent) who had all relevant facts.
- IRS error: IRS provided incorrect written advice or failed to provide requested forms/instructions.
What does NOT qualify as reasonable cause
- Ignorance of the law ("I didn't know I had to file")
- Lack of funds to pay tax (not reasonable cause for failure to pay)
- Reliance on non-professional advice (friend, family member)
- Misunderstanding simple tax rules
- Mistake by tax software
How to request reasonable cause abatement
Send a written statement to the IRS explaining:
- What penalty you're requesting to be abated
- The facts and circumstances causing the failure
- Why these circumstances constitute reasonable cause
- What steps you took to comply once circumstances changed
- Supporting documentation (medical records, insurance claims, professional correspondence)
Mail the statement to the IRS address shown on the penalty notice, or call the number on the notice to request reasonable cause consideration.
First-time penalty abatement (FTA)
IRS first time penalty abatement is an administrative waiver available for taxpayers with clean compliance history.
FTA eligibility requirements
To qualify for IRS first time penalty abatement:
- Clean compliance history: You didn't have penalties (other than estimated tax penalties) for the three tax years prior to the tax year with the penalty you're requesting to be abated.
- Filed all required returns: You filed all currently required returns or filed an extension.
- Paid or arranged to pay: You've paid all tax owed or arranged an installment agreement.
Which penalties FTA covers
IRS first time penalty abatement applies to:
- Failure-to-file penalties
- Failure-to-pay penalties
- Failure-to-deposit penalties (employment taxes)
IRS first time penalty abatement does NOT apply to:
- Accuracy-related penalties
- Fraud penalties
- Information return penalties (Forms 1099, W-2)
- Estimated tax penalties
Example: Using first-time abatement
Your 2024 S-corporation return was filed 2 months late, resulting in $3,500 in penalty for filing taxes late. You had no penalties in 2021, 2022, or 2023. You've now filed all returns and paid all taxes.
You request IRS first time penalty abatement. The IRS grants it, abating the full $3,500 penalty. You still owe interest but the penalty is removed.
How to request FTA
There are three ways to request IRS first time penalty abatement:
Option 1: Phone request - Call the IRS phone number on your penalty notice (typically 1-800-829-1040 for individual taxpayers). IRS staff can grant FTA over the phone if you meet the eligibility criteria. This is often the fastest method.?
Option 2: Written letter - Write a letter requesting IRS first time penalty abatement and mail it to the address on the penalty notice. Include:
- Your name, address, and taxpayer identification number
- The tax year and penalty type you're requesting abatement for
- A statement that you're requesting First-Time Penalty Abatement
- Confirmation that you meet all three eligibility requirements (clean filing history, all returns filed, all taxes paid or arranged)
- Your signature and date?
Option 3: Form 843 - Complete IRS Form 843 (Claim for Refund and Request for Abatement) to formally request penalty abatement. This form provides a structured format for your request and creates a clear paper trail.?
When completing Form 843:
- Part I: Enter your personal information
- Part II: Check the box for the type of penalty you're requesting to be abated
- Part III: In the explanation section, state "Requesting First-Time Penalty Abatement" and confirm you meet eligibility requirements
- Attach documentation of your clean compliance history if available
- Mail to the address shown on your penalty notice
FTA is a one-time relief
Once you use IRS first time penalty abatement, you must maintain three more years of clean compliance before you're eligible again. Use FTA strategically for your largest penalty.
Penalty interest compounds daily
In addition to penalties, the IRS charges interest on both unpaid taxes and unpaid penalties. Interest compounds daily.
Current interest rates
The IRS interest rate is the federal short-term rate plus 3% for individuals and businesses. As of late 2024/early 2025, the rate is approximately 8% annually.
The rate is adjusted quarterly and can change.
Interest applies from due date
Interest begins accruing on the due date of the return (April 15, March 15, etc.) regardless of extensions. Extensions extend the filing deadline but not the date from which interest is calculated.
Interest is compounded daily
Interest compounds daily, meaning interest accrues on previous interest. This can significantly increase the total amount owed over time, as any tax penalty calculator will demonstrate.
Interest cannot be abated
Unlike penalties (which can be abated for reasonable cause or through IRS first time penalty abatement), interest cannot be abated except in rare cases of IRS error. You owe interest on underpayments regardless of the reason for underpayment.
Common mistakes that trigger business tax penalties
Mistake #1: Not filing an extension and missing the deadline
Many business owners assume their accountant will automatically file an extension. If the accountant doesn't and the return is late, you owe a 5% per month penalty for filing taxes late.
Prevention: Confirm with your accountant that extensions are filed, or file them yourself using Form 7004 (business) or Form 4868 (individual).
Mistake #2: Filing an extension but not paying estimated tax
An extension extends the filing deadline, not the payment deadline. You must pay at least 90% of your tax liability by the original due date to avoid failure-to-pay penalties.
Prevention: Make an estimated payment when filing the extension through qualified business tax services.
Mistake #3: Not making quarterly estimated tax payments
Self-employed individuals and business owners often don't pay estimated taxes throughout the year, thinking they can pay it all at filing. This triggers estimated tax penalties.
Prevention: Make quarterly estimated payments using the safe harbor rules (100% of prior year tax or 90% of current year).
Mistake #4: Overstating deductions without documentation
Claiming aggressive deductions without adequate documentation or reasonable basis triggers 20% accuracy-related penalties when audited, potentially escalating to small business tax evasion penalties in extreme cases.
Prevention: Maintain detailed records for all deductions and consult a tax professional for unclear areas.
Mistake #5: Not filing information returns (1099s, W-2s)
Businesses often forget to file Forms 1099 for contractors or file them late, triggering $60-$310 per form penalties.
Prevention: Track all contractor payments throughout the year and file Forms 1099-NEC by January 31.
Mistake #6: Not using first-time abatement when eligible
Taxpayers with clean compliance history often don't know IRS first time penalty abatement exists and pay penalties they could have eliminated.
Prevention: Always check if you qualify for FTA before paying failure-to-file or failure-to-pay penalties. Use a tax penalty calculator to estimate savings.
What are some payment plan options if I can't afford to pay?
If you can't pay your tax liability in full, several options are available that can reduce penalties while you pay over time.
Installment agreement
An installment agreement allows you to pay your tax debt over time (typically 6-72 months). While enrolled in an installment agreement and making payments, the failure-to-pay penalty is reduced from 0.5% to 0.25% per month.
You can apply for an installment agreement online through the IRS website, by phone, or by mailing Form 9465.
Short-term payment plan
If you can pay within 180 days, request a short-term payment plan. There's no setup fee (unlike long-term installment agreements), though penalties and interest continue to accrue.
Offer in Compromise
If you can't pay the full amount and likely never will be able to, you may qualify for an Offer in Compromise—settling your tax debt for less than the full amount.
The IRS considers your ability to pay based on income, expenses, and asset equity. Offers in Compromise are difficult to qualify for and require detailed financial disclosure.
Currently Not Collectible status
If you can prove paying the tax would create financial hardship (inability to pay basic living expenses), the IRS may place your account in Currently Not Collectible status, temporarily suspending collection efforts.
Penalties and interest continue to accrue, but the IRS won't actively pursue collection until your financial situation improves.
How NSKT Global can help with business tax penalties
NSKT Global specializes in tax penalty defense and compliance for businesses and self-employed individuals, helping minimize or eliminate penalties through strategic abatement requests and compliance planning.
We offer comprehensive penalty defense services including reasonable cause statements preparing detailed explanations with supporting documentation requesting penalty abatement, IRS first time penalty abatement requests identifying eligibility and submitting FTA requests for maximum penalty relief, accuracy-related penalty defense challenging 20% penalties through reasonable cause arguments or showing substantial authority for tax positions, estimated tax penalty reduction calculating alternative methods to minimize or eliminate estimated tax penalties, and IRS penalty appeals representing clients when initial penalty abatement requests are denied.
Whether you filed or paid business taxes late and received penalty for filing taxes late or failure-to-pay penalty notices, received accuracy-related penalty assessments after an IRS audit or examination, missed filing Forms 1099, W-2, or other information returns triggering per-form penalties, or didn't make quarterly estimated tax payments and owe underpayment penalties, our expertise ensures you identify all available penalty relief options including reasonable cause and IRS first time penalty abatement, prepare compelling abatement requests with proper documentation and legal arguments, minimize or eliminate penalties that can add 20-50% to your tax liability, and establish systems to prevent future penalties through timely filing, payment, and compliance with all business tax obligations.
