The IRS Versus the Taxpayer
According to the IRS, not only is your ignorance no excuse, but so is that of your tax preparer. In other words, the fact that your tax preparer made a mistake is no excuse and will not absolve you from compliance penalties.
Unfortunately, the penalty for making what could be deemed an innocent mistake can cost a taxpayer a significant sum. What is worse yet is that defending yourself against the IRS is a costly endeavor in terms of both time and money. Part of the problem is that taxpayers often do not have the option of making an appeal directly to the tax court and, instead, must first pay the IRS and then challenge it in either District Court or the Court of Claims. Stated plainly, the average taxpayer simply cannot afford to fight the IRS in tax court.
In the remainder of this article, we will look at two main areas that tend to be problematic for taxpayers: first, assorted penalties for misfilings and mistakes; second, obscure international forms.
Miscellaneous Mishaps and Mistakes
Taxpayers can get caught up in “gotcha” type situations where they inadvertently make a mistake in the type, accuracy or timing of the filings. Here is a checklist of some of most common issues in which taxpayers typically make unintentional errors that will not be forgiven by the IRS.
- Filing late and paying short: Filing a return late and underpaying the tax owed each carry separate penalties. Together, these penalties can add up to 47.5 percent of the original tax owed in a worst-case scenario.
- Careless Filing Details: If you make a mistake in filing your return and it results in tax liability in your favor, you can owe a penalty of 20 percent of the under-reported taxes. In the case of faulty appraisals for items such as donated property, the penalty can double up to 40 percent.
- Writing Bad Checks: Technically it does not matter if it is a physical check or another payment method, but if a taxpayer’s payment to the IRS is declined, the IRS will change an additional 2 percent penalty.
- Missing Checklists: Failure to file the two-page “due diligence” checklist before claiming certain credits, such as the earned-income or college credits, can result in a fine of $545 per credit.
Obscure International Forms
Many compliance-related rules related to international investments and banking activities were originally created to put a stop to drug dealers, terrorists and flagrant tax cheats. Unfortunately, the regulations are still in force, but apply to increasingly more taxpayers as the threshold amounts have not increased yet more U.S. citizens are working, living or retiring abroad. Moreover, the penalties can be severe. In this section, we will look at some of the most obscure and serious foreign tax compliance issues.
- Passive Foreign Investments: If you own mutual fund shares incorporated abroad you must file Form 8621.
- Personal Holding Companies: If you create a corporation to hold a foreign property, you will need to file Form 5471, for a Controlled Foreign Corporation.
- FBAR: If you have $10,000 or more in any combination of international bank and brokerage accounts, at any single point in the year, you need to file the FBAR form electronically. Note, the trigger here is that the bank or brokerage is outside the United States. If you hold securities of foreign companies or foreign currencies with a U.S. institution, the reporting is not required.
- Fatca Disclosures: Facta disclosures were created to combat money laundering, covering all manner of foreign financial assets, including insurance and retirement assets. It can overlap with the FBAR requirements, but the additional reporting here is triggered by higher thresholds starting at $50,000 in assets for single U.S. residents and up to $400,000 for couples residing abroad and filing joint returns.
Remember that ignorance of the tax law is no excuse, especially in the eyes of the IRS. It does not matter if a mistake you make is truly innocent; there is still a good chance that you will end up paying unpleasant fines and penalties and, in the worst case, a big mess. It is best to be timely and diligent in your filings.