Free Corporate Tax Penalties Term Paper Example
What are Corporate Tax Penalties?
Corporate tax penalty refers to the punitive tax applied on a local or federal level for deterring non-compliance, including underpayment of income tax, filing income tax return past the due date, and failing to file a tax return. In the USA, the Internal Revenue Service (IRS) has the primary responsibility of issuing corporate tax penalties at the federal level (“Publication 542-Main” 2011). State and local rules related to corporate tax penalties, however, vary, and those are executed by the state and local governing authorities.
Purpose and Scope
The purpose of tax penalty is to make sure that corporations properly file their taxes on time and reduce the number of unethical tax evasion practices. If a corporation is responsible for filing tax return, then they must be aware of the late or no filing penalties that the Internal Revenue Service (IRS) imposes for different reasons. Corporate penalty rules are different from that of applied on individuals. Corporates need to file a tax return even if they have no taxable income to report or else they may face penalty from the IRS. This essay will discuss the corporation tax penalty clauses in greater detail.
Reasons for Being Assessed
Filing past due date and Failure to File
There are penalties involved when a corporation fails to file a form 1120 by the deadline. Corporations, without any tax due, are charged with a non-filing penalty of $195 per month, which is multiplied by the number of shareholders for every month of late filing (Rogers 2013). For example, if an S corporation has five corporate shareholders, then for each month of late filing, that company will be paying a penalty of $975 ($195 X 5) per month, assuming that the corporation has no pending income tax (Rogers 2013). However, if a corporation, which has tax due, fails to file tax by the deadline then the penalty is higher.
Underpayment of Taxes Due
It may sound like as if it does not matter if a corporation is late for five months in filing tax returns as the penalty does not go up. However, that is not the case. IRS charges other penalties apart from the late filing penalties. It charges a penalty of 0.5% for each month of delay to a corporation that owes tax to the IRS. Non-filing penalty and this additional penalty accrue at the same time. Non-filing penalty may not accrue after 5th months, but unpaid tax penalty continues to accrue. In total, the penalty can go up to as high as 47.5% of the total unpaid amount as combined penalty (Marz 2014). Apart from these two types of penalties, the IRS also charges interest on the unpaid amount until the total amount of unpaid tax is fully paid off. For example, a corporation owes $10,000 to the IRS as unpaid tax and fails to file. The maximum filing penalty the IRS will impose is 25% or $2,500 if it is not filed till month 5 or beyond. Apart from non-filing, the corporation will accrue an amount due penalty of 0.5% or $50 per month and will continue to accrue till the time the whole amount is paid off (Marz 2014). Apart from that, the IRS will also charge an interest on the outstanding tax amount.
Late Payroll Tax Filing
Over and above that, a monthly penalty of 5% of the income tax that remains unpaid is also charged as penalty to the corporations. The penalty is capped at 25%. In other words, if an organization delays to file tax by 5 months, then it will pay a 25% penalty on the tax due, but if that organization delays filing tax by 10 months, still then it will pay a penalty of 25%. For example, a corporate has a $10,000 tax due and fails to file tax returns before the deadline. Then it will be charged a penalty of 5% of the due amount or $500 per month on the amount due. However, the corporation will be charged a maximum of $2,500 as penalty after 5 months of delay, which will not go up even if the corporation delays filing tax for more than 5 months (Rogers 2013). However, apart from this penalty, the corporation will also have to pay the other penalty of $195 per month, which will be multiplied by the number of corporate shareholders.
Apart from year end corporate tax filing, corporations are also liable to pay quarterly payroll tax to the IRS. Failing to do so also can cause penalty for the organization. The penalty for failing to file payroll tax return is 5% per month and can go up to 25% maximum. For example, if a corporation has a quarterly payroll tax liability of $5,000 every quarter and fails to file return and pay quarterly payroll tax, then it will incur a penalty of $250 per month (Rogers 2013).
Types of Penalties
Accuracy Related Penalty
Accuracy related penalty can be of mainly two types; negligence and understatement. In both cases, the usual tax penalty applies as discussed in the previous section. Accuracy related extra penalty is 0.5% of the amount underestimated and is capped at 25% (Marz 2014). However, in the case of severe understatement of tax, the IRS can file for a criminal action against the corporation, which, apart from the usual tax penalties, can result in severe legal action, including prison sentencing of the corporate directors, trustee or the management (Rogers 2013).
Misstatement of Property Value and Gross Evaluation
Many a times, corporations undervalue of overvalue a property for tax reduction. For example, in the event of a merger, a lot of time the buyer corporation overstates the value of the property and assets so that it can depreciate the value at a higher rate and lower its tax base. However, if not done properly, the IRS may find an irregularity leading to the imposition of 0.5% penalty (Marz 2014).
Intentional filing of false tax returns is called fraud. Any person who has committed tax fraud is subject to criminal offense. Anyone doing or aiding in such tax fraud may subject to jail and forfeiture of property. The IRS does not directly impose penalty in these cases, but the penalty is imposed via the court system.
Trust Fund Recovery Penalty
If income, Medicare and social security taxes that a corporation deducts from the employee salaries are not paid to the United States Treasury or are not deposited to the Treasury of the IRS, then it will incur a penalty known as the trust fund recovery penalty. This penalty is equal to the full amount of the unpaid trust fund tax. If these unpaid amounts cannot be collected immediately, then the penalty is applied to the corporation (Marz 2014). This trust fund recovery penalty is imposed on one or more people responsible for depositing the amount. Responsible person can be a director, trustee, accountant or an officer. He can be someone who writes a check or makes payments on behalf of the corporation.
Abusive Tax Shelters
In abusive tax shelter, a corporation schemes an investment in a way to reduce the income tax without any change in the user’s value of assets or income. These shelters have no economic purpose other than tax evasion. Abusive tax promotors and investors are again subject to legal system, and the penalty is levied on them via a court system and not the IRS.
There are few exceptions to the penalty rule for the underpayment of taxes. Sometimes, some part of the penalty can be waived or it can be waived fully for corporations if the below two cases can be proved:
The corporation has a reasonable cause for not making the payment on time. In this case, the penalty for not filing is waived.
The corporation did not willfully underpay the taxes. Then the IRS may take a decision to reduce the penalty amount based on the situation.
Abatement of Civil Penalties
The abatement of tax is a situation where the IRS or the court finds corporations under such situation that if a tax remains unpaid by the corporation, it does not lead to civil penalties. For example, there is a 100% tax penalty for not paying trust fund taxes, and there is 0.5% for not paying employee payroll taxes (“Abusive Tax Shelters” 2013). In harsh economic conditions, a company may willfully bypass some types of tax and then apply for abatement to the IRS or apply in the court. Many companies after the 2008 recession applied for the abatement to bypass or delay the payroll tax penalty as they were unable to fully pay the taxes on time because of harsh economic conditions.
How to Prevent Penalties
Some of the times, corporations fail to file or pay on time due to many constraints. In such cases, the best way to avoid penalty is to file for an extension. Corporations can file for an extension by filling in the form 7004 which is then sent to the IRS via ordinary mail, or they also can fill in this form electronically to get an automatic extension of the filing deadline. However, form 7004 should be filled and submitted before the original filing date deadline. Filing the form 7004 gives a corporation an additional 6 months to file its income tax return (Fitzpatrick 2014). This will make sure that for that 6 month period, the corporate will not incur any late filing penalty. However, there is no reduction in the penalty for the amount of tax due. For example, an organization owes a tax amount of $10,000 and files for an extension by filling up the form 7004. Therefore, for the next 6 months, the corporation will not incur the 5% per month penalty for not filing. However, because of unpaid tax amount of $10,000, it will continue to owe 0.5% of the tax amount of $50 per month as penalty (Fitzpatrick 2014).
Complying with the Law and Conclusion
Above mentioned penalties are the most common penalties imposed on corporations by the IRS. Apart from these, the IRS can also impose criminal penalties for non-filing if the IRS thinks that the corporation is illegally trying to suppress income tax. For Limited Liability Company, the partners of the firms must file an annual partnership return or else they will also incur similar tax penalties like the shareholders of a corporation. If a corporation cannot file tax return on time, the best possible option is to file a form 7004 to get an extension for six months. However, the best way to deal with unpaid tax is to plan well ahead and pay on time to avoid any penalty.
“Publication 542-Main Content”. IRS. 2011. Web. Web. 28 Feb. 2015 <http://www.irs.gov/publications/p542/ar02.html#en_US_2011_publink1000257782>
Rogers, Karen. “Penalties for late Income Tax Filing for S Corporations”. Demand Media. 2013. Web. 28 Feb. 2015 < http://smallbusiness.chron.com/penalties-late-income-tax-filing-s-corporations-63696.html>
Marz, Michael. “Penalty for Failure to File Corporate Tax Return”. Demand Media. 2014. Web. 28 Feb. 2015 < http://smallbusiness.chron.com/penalty-failure-file-corporate-tax-return-64551.html>
Fitzpatrick, Diana. “How to Avoid estimated tax penalties”. NOLO Law for All. 2014. Web. 28 Feb. 2015 < http://www.nolo.com/legal-encyclopedia/estimated-tax-penalities-how-avoid-underpaying.html>
“Abusive Tax Shelters and Transactions”. IRS. 2013. Web. 28 Feb. 2015 <http://www.irs.gov/Businesses/Corporations/Abusive-Tax-Shelters-and-Transactions>