The U.S. Internal Revenue Code imposes tax penalties of gradually increasing severity on taxpayers who overstate their deductions. The least severe penalties involve moderate fines and interest penalties based on the amount that you owe, while the most severe penalties involve heavy fines and sometimes even years in federal prison. You can be penalized with more than one tax penalty at the same time -- a failure-to-pay penalty plus a negligence penalty, for example.
The Failure-to-Pay Penalty
Overstating your deductions means understating your tax liability. If you fail to pay all that you owe by the due date, the IRS will add a penalty of 0.5 percent of the overdue amount for each month or part of a month that you fail to pay. The maximum penalty is 25 percent of the amount you owe. The IRS will also add an interest penalty; in 2012, this penalty is set at 3 percent above the federal short-term rate. There is no maximum interest penalty.
Negligence and Disregard Penalties
The IRS will charge a penalty of 20 percent of the amount due if your tax return indicates that you made no reasonable attempt to comply with the tax code, or if it indicates that you recklessly disregarded tax rules. It will also impose this penalty if your overstated deductions total at least 10 percent of your total amount due, or if you understate your total tax liability by at least $5,000.
Filing a Frivolous Return
The IRS can charge a fine of between $500 and $5,000 if you take a frivolous position on your tax return -- by claiming the home office deduction "because I work so much overtime I practically live at the office," for example. Your tax return may also be considered frivolous if you claim a deduction but don't include enough information to allow the IRS to calculate how much it is actually worth.
Civil Fraud Penalties
You can be penalized up to 75 percent of your overdue amount if you commit fraud on your tax return. Fraud is more than simple negligence -- it involves an active intent to deceive the IRS. For example, you might be fined for fraud for attempting to take advantage of certain tax deductions by filing jointly with someone who is not actually your spouse.
Tax evasion is a criminal offense. You commit tax evasion when you deliberately understate your tax liability or try to hide your assets, which means that civil fraud can also be classified as tax evasion. The maximum penalty for tax evasion is five years in federal prison and a fine of $250,000, although a lesser penalty is likely depending on your degree of fault and the amount of tax you evaded.
- Internal Revenue Service: Failure To File/Failure To Pay Penalties
- Internal Revenue Service: Return Related Penalties
- LawFirms.com: Criminal Tax Evasion
- Alvin Brown and Associates: Background Information on IRS Tax Penalty
- Internal Revenue Service: - IRS Notices and Bills, Penalties and Interest Charges
- Nolo: Negligence Versus Tax Fraud: How Can the IRS Tell the Difference?
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