Let’s address an unfortunate reality: as a business owner, you have a greater number of tax reporting obligations than a regular person has. (Of course, you have MANY more tax-savings opportunities as well.)
But with those increased obligations comes increased opportunity for things to slip through the cracks, potentially resulting in business tax penalties and interest charges from the IRS.
Some of these penalties are straightforward and simple. Others get really complex in how they’re calculated.
Of course, your best course of action is to just let us deal with all of this for you. This is, after all, what we do.
But just in case there’s any question in your mind about what your filing and payment responsibilities are to the IRS for your business, let’s run through them from the perspective of the business tax penalties that can be assessed if you don’t take care of them.
Buckle up, partner. There’s lots in here…
Keith Cole, CPA, EA’s Three Business Tax Penalties To Avoid When Possible
“Tell me and I forget. Teach me and I remember. Involve me and I learn.” – Benjamin Franklin
Your Washington, DC Metro Area business may have a variety of tax return filing requirements. The exact forms you need to file will depend on the legal structure of your business, whether you have employees or utilize independent contractors, and the dollar amounts of some of the taxes you have to pay.
There are over 150 different penalties in the Internal Revenue Code. In this Strategy Note, we’ll cover the most common ones you need to be aware of.
Business Tax Penalty #1: Income Tax Return Penalties
Just like you need to file a 1040 return each year for your personal income taxes, your Washington, DC Metro Area business has tax return filing requirements, too.
If you operate your business as a sole proprietorship, your business tax return is the Schedule C that gets attached to your personal 1040 return. If you don’t pay in enough tax money throughout the year, you may end up owing an Estimated Tax Penalty from your self-employment income. In addition, you could be subject to Failure to File and Failure to Pay penalties, which we’ll go into detail below.
If your business operates as a partnership, you must file a Form 1065, Partnership Income Tax Return, each year. If you file this partnership tax return late, you’ll be charged an IRS penalty of $210 for each month it’s late, times the number of partners. This penalty is maxed out after 12 months of being late.
So, for example, if your business has four partners, and you file the tax return 14 months late, your penalty would be: $210 x 4 x 12 = $10,080. That’s a big check to write to the IRS for a tax return that normally doesn’t have any taxes due!
But wait, there’s more! Since each partner in the partnership is required to receive a Form K-1 from the partnership, reporting their share of income, the IRS imposes additional penalties for failure to provide these K-1 forms. This penalty starts at $280 per K-1, and increases significantly if the requirement to issue the K-1 was “intentionally disregarded.” This intentional disregard is difficult for the IRS to prove, but if they can do so, the maximum penalty against the partnership can be up to $3,392,000.
That’s not a typo. The maximum penalty can be over three million dollars. Such penalties are incredibly rare, but they do happen.
If your business operates as a subchapter-S corporation, you must file a Form 1120S each year to report the business’ income, expenses, and other information. The same $210 per month penalty applies, multiplied by the number of shareholders of the corporation during the year. In addition, the same $280 penalty can be imposed for not providing the appropriate Form K-1 to shareholders on time.
Bottom Line: File these returns on time! There is usually no income tax due on a 1065 or 1120S return, so you should have no concerns about paying a balance due. The issue that most businesses face is that their bookkeeping isn’t up to date to get these returns prepared. We can help you get caught up and get returns filed to avoid these massive penalties.
Business Tax Penalty #2: Employment Tax Penalties
If you have employees within your Washington, DC Metro Area business, then the payroll taxes that you pay to the IRS in relation to those employees are one of the highest enforcement priorities for the government. Over half of all the tax debt owed to the IRS is employment tax debt. These taxes consist of income tax withholding from your employees, plus both halves of Social Security and Medicare taxes.
Depending on your total payroll tax liability for each quarter during the previous year, the frequency with which the IRS expects to receive employment tax payments from your business can change. However, the vast majority of small businesses must deposit these taxes on a monthly basis.
If your business fails to make the required tax payment, you may be subject to a Failure to Deposit (FTD) penalty. This penalty is pretty stiff, and increases the longer it takes you to pay. The penalty is:
2% if you’re 1 to 5 days late
5% if you’re 6 to 15 days late
10% if you’re more than 16 days late and the IRS hasn’t sent you a bill
15% if the IRS sent you a bill and has to chase you down for the money
In addition to making these routine tax deposits, most businesses also need to file a quarterly tax return to report wages, income tax withholding, and Social Security and Medicare taxes, among other items. If you file this tax return — Form 941 — after the due date, you can also be subject to a Failure to File (FTF) penalty of 5% per month, which caps out at 25%.
On top of these two penalties, the IRS will charge you a Failure to Pay (FTP) penalty on top of the FTD and FTF penalties. This penalty will accrue at the rate of:
0.5% per month as the base rate
Reduced to 0.25% per month if you’re on a payment plan
Increased to 1% per month if the IRS has threatened to seize some of your assets, and you still don’t pay
This FTP penalty has a maximum cap of 25%. If you don’t file and don’t pay, you do get a slight break, as the combination of the FTF and FTP together caps out at 47.5% combined.
With all these penalties combined — FTD, FTF, and FTP — the total can equal up to 62.5% of the tax liability.
Oh, and to top it off, they charge 3% interest on both the tax and penalties.
Can you see the IRS clearly isn’t playing around when it comes to employment taxes?
Business Tax Penalty #3: Information Return Penalties
Are your penalties out yet? The IRS has many, many more penalties to throw at your Washington, DC Metro Area business. Here are two super important ones to also be aware of.
– If you utilize the services of independent contractors within your business, you’ll need to file a Form 1099-NEC for each contractor that you pay over $600 in a year. If you file this return late, the IRS may assess a penalty between $50 and $270 per 1099, depending on how late you file it. This penalty is interesting because it can be assessed for both the copy of the 1099 you’re supposed to send to the contractor and the copy you’re supposed to send to the IRS — effectively doubling it.
– If you have employees, you also need to prepare and file a Form W-2 for each employee, plus a Form W-3 to reconcile them with the IRS. Filing these late incurs similar penalties as those 1099 forms, ranging from $50 to $280, depending on how late you file them.
Both of these penalties are subject to the same $3,392,000 maximum penalty described earlier.
Are you convinced that you should leave all of this to the professionals? If you’d like a review of your business filing requirements to avoid these and the other 100+ penalties the IRS can assess, let’s talk.
To getting things done,
Keith A. Cole
Keith Cole, CPA, EA