Most taxpayers don’t intentionally incur tax penalties, but many who are penalized are not aware of the penalties or their potential financial impact. As tax season approaches, you must familiarize yourself with common tax penalties and ways to avoid them.
Below are 14 key tax penalties that taxpayers may encounter in 2025 and tips for minimizing risks.
1. Underpayment of Estimated Tax and Withholding Penalty
The U.S. operates on a pay-as-you-earn tax system, requiring taxpayers to pay their liabilities through withholding or estimated tax payments. If your tax owed exceeds $1,000 when filing, the IRS may assess an underpayment penalty of 3% of the underpaid amount. Safe harbor payments include 90% of the current year’s liability or 100% (110% for high-income earners) of the previous year’s liability. Farmers and fishermen have reduced requirements. Stay on top of quarterly payments to avoid this penalty.
2. Required Minimum Distribution (RMD) Penalty
Tax-deferred retirement plan holders must withdraw their RMD annually upon reaching age 72. Failure to do so incurs a 50% penalty on the amount not withdrawn. While the IRS is lenient with waivers for valid reasons, staying proactive ensures compliance.
3. Late Filing Penalty
Failing to file your tax return by the deadline results in a penalty of 4.5% per month (maximum 22.5%) of unpaid taxes. Returns more than 60 days late incur a minimum penalty of $435 or 100% of the tax due, whichever is less. Filing timely or requesting extensions can help you avoid this penalty.
4. Late Payment Penalty
Taxes owed but not paid by the original due date incur a 0.5% penalty per month (maximum 25%). To avoid this, pay as much as possible by the due date, even if you need an extension to file.
5. Negligence Penalty
Errors or omissions due to taxpayer negligence can result in a 20% penalty on the underpaid tax. Accurate reporting and professional guidance are crucial to prevent this penalty.
6. Fraud Penalty
Tax underpayments due to fraud are penalized at 75% of the unpaid tax. Intentional misrepresentation is severe and best avoided through honest reporting.
7. Dishonored Check Penalty
For checks over $1,250, a 2% penalty applies. For amounts $1,250 or less, the penalty is $25 or the check amount, whichever is lower. Avoid writing checks if funds are insufficient; explore IRS payment plans instead.
8. Missing ID Number Penalty
A $50 penalty applies per missing Social Security Number (SSN) for taxpayers, dependents, or other entities on tax returns. Ensure all required identification numbers are included to avoid this penalty.
9. Early Withdrawal Penalty
Withdrawing from retirement plans before age 59½ incurs a 10% penalty. Exceptions apply, such as COVID-19-related hardships in prior years. Familiarize yourself with qualifying exemptions to reduce tax liability.
10. Failure to Report Tips Penalty
Unreported tips are subject to a penalty of 50% of the unpaid Social Security tax. Regularly report tips to your employer to stay compliant.
11. Foreign Reporting Penalty
Failure to disclose foreign financial accounts or assets may lead to substantial penalties. If you have foreign holdings, consult a tax professional to ensure proper reporting.
12. Excessive Claim Penalty
Claiming a refund or credit exceeding allowable amounts incurs a 20% penalty on the excessive claim. Ensure your claims are reasonable and well-documented to avoid this issue.
13. Frivolous Return Penalty
Submitting a frivolous return incurs a $5,000 penalty. This includes filings with incorrect or missing information aimed at obstructing tax laws. Filing accurately and honestly is key.
14. Failure to File Information Returns Penalty
Missing or incorrect information on required returns incurs a $280 penalty per return. Corrections made within 30 days or by August 1 can reduce penalties to $50 or $110, respectively.
Tips for Avoiding Tax Penalties
- File and pay taxes on time.
- Use safe harbor rules for estimated taxes.
- Keep detailed records and double-check your filings.
- Consult tax professionals for complex situations, especially foreign accounts or retirement distributions.
Final Comments
Understanding tax penalties is crucial to avoiding unexpected financial burdens. Whether it’s the underpayment penalty or issues like excessive claims, being informed helps taxpayers make better decisions and save money. Contact a tax professional if you need assistance navigating these penalties or reducing their impact on your finances.
