To most small business owners, there’s basically nothing worse than paying taxes—except finding out that you owe even more than you planned because of IRS penalties. These can amount to hundreds if not thousands of dollars of unwelcome (if not unexpected) charges.
While receiving a letter from the IRS saying you’ve been issued a penalty may elicit a groan followed by a joking “can I just not pay this?” far too few small business owners realize that there are often totally legal ways to get out of paying IRS penalties. So before you just hastily write a check to avoid having to think about it anymore, it’s worth exploring avenues for getting your penalties forgiven (either on your own or with the help of your CPA).
Here are several common penalties small business owners face, and the steps you can take to try and reduce or remove those penalties.
Late Payment or Filing Penalty
The most common penalty folks face is for filing and/or paying their tax returns late. For late filing, the IRS charges 5% of the tax owed for every month the return is late up to a max of 25%. For late payment, you can expect a 0.5% fee on the unpaid taxes, again up to 25% of taxes owed. That can add up fast.
The first way to avoid a penalty here, of course, is to ask for permission rather than forgiveness—if you know you are going to need extra time to file for your returns, file for an extension before tax day using Form 4858 if you’re filing as a sole proprietor or Form 7004 if you’re operating as a corporation. While you’ll still need to pay what you expect your tax to be by tax day, this grants you extra time to get your affairs in order to file.
But assuming you’ve already missed the mark and gotten hit with a late filing or payment fee, you still have a few options for relief.
If this is your first time filing or paying late, you’re likely to get off easy. If this is your first offense and the past three years have been totally penalty-free (excluding the estimated tax penalty) simply ask the IRS representative you’re talking to for “first-time penalty abatement.” Done and done. (NOTE: There used to be a rule that allowed you to use this method every three years that you haven’t been hit with the penalty, but that rule was recently removed.)
If you don’t qualify for the first-time abatement, you do need to give the IRS a good excuse—also known as “reasonable cause”—for your late filing or payment. What’s considered a reasonable cause can vary, but basically, it amounts to demonstrating to the IRS that you exercised ordinary business care and prudence and still were unable to meet deadlines because of something outside of your control. Some common reasonable causes include death or serious illness of you or an immediate family member, natural disasters or fires, or inability to obtain necessary records. Regardless of the reason, be prepared to explain the timeline of the event, why it prevented you from filing or paying on time, and how you resolved the issue as soon as possible.
If you can’t get rid of the penalty entirely, reducing your tax load could at least reduce it, so double check your return to make sure you’re only paying what you truly owe.
2. Failure to Pay Proper Estimated Taxes
Another common penalty among small business owners and 1099s is failing to pay estimated taxes throughout the year—similar to paying these taxes late since the government didn’t have their money when they were expecting it. This is less of a flat fee and is calculated based off how late your tax is considered to be and what the interest rate at the time was.
You can avoid these penalties in the first place by remembering to pay estimated taxes every quarter, or increasing your contributions from a W2 job (if you have one) to cover the taxes you’ll owe from side income.
Unfortunately, if you just forgot to pay your estimated taxes, you’ll need to swallow it and pay up (then set reminders on your calendar for next year!). But if you didn’t pay at some point because of casualty, disaster, or another unusual circumstance, you may be able to remove the penalty. If you haven’t filed yet, include Form 2210 with your tax return—along with an explanation of your missed payments and documentation to support your statement—in order to request a waiver for the penalty. If you’ve already filed, use Form 843 along with a similar explanation and documentation to request the penalty be removed.
3. ACA Health Insurance Mandate Penalty
While the 2018 tax reform removed the penalty for not having proper health insurance coverage, this won’t come into effect until the 2019 tax year (filed in 2020)—so some of you still may face this penalty this year. If you don’t have essential health insurance coverage, you could be facing $695 or more in penalties (depending on your household income).
The only way to get out of this penalty is to see if you qualify for one of the exemptions, which can include things like certain hardships, healthcare being unaffordable, having only a short gap in coverage or living abroad. Even if you don’t apply for an exemption for the entire year, proving one applied to you for a few months can at least reduce your penalty. Most of these exemptions are claimed with Form 8695 when you file your return.
Some final notes: When stating your case against a penalty, never use an excuse like you forgot or didn’t know about the law—it won’t help you out. You also can’t blame your tax preparer (although they might be able to help you figure out how to reduce or remove it!). If the IRS made a mistake that led to your penalty, however, you should not have to pay it. Finally, if your request to remove a penalty is rejected, you can appeal it. The IRS has a tool to guide you through this process.
Need Help Understanding Your IRS Notice or Penalties?
Abridged by Amy:
- Before automatically paying for a penalty, explore if there are ways to remove or reduce it—there are many legal avenues for doing this!
- If you’re facing a late payment or filing penalty, the first-time abatement is the easiest way to get out of it. Barring this, you’ll need to give the IRS proof of reasonable cause for missing your deadlines.
- If you’re facing a penalty related to paying estimated taxes, explore if there was reasonable cause you can prove to get you out of paying that penalty.
- The ACA health insurance mandate penalty is disappearing soon, but if you’re facing a penalty this year for not having essential health insurance coverage, check the list of exemptions to see if any of them apply to you for all or part of the year.