Accounting and tax professionals have a lot to keep up with. Besides their own business compliance considerations, they also handle many important filings for their clients, like those listed below:
- Quarterly and annual income tax returns and payments;
- Sales tax returns;
- Payroll tax withholdings, reports and payments; and,
- Compliance filings (e.g., annual reports).
So, what happens if something slips through the cracks — missing a tax filing, forgetting to send a payment, or failing to meet some other compliance task deadline? What are the consequences for the service provider and client? And what is the protocol for fixing those types of mishaps?
How do you know if a requirement or deadline was missed?
Government agencies to which filings and payments are due will contact clients/taxpayers about any past-due obligations and associated penalties by notice (a letter sent through traditional mail).
The notice will contain critical information including:
- Type of penalty;
- Instructions for requesting abatement of — or appealing — the penalty; and,
- Methods to contact the government agency to respond to the notice.
Usually, the government agencies issuing notices allow the client taxpayer or the client's accounting professional to respond via mail, phone, fax or online.
Possible consequences
Generally, if an accounting professional misses a tax filing, payment or compliance task deadline for a taxpayer, the client will be subject to penalties and interest on the missed or late filing or payment. Ultimately, even when enlisting the services of a licensed professional, the client owns responsibility for the filing of their own tax returns and making payments.
However, if an accounting professional behaves in a negligent or unprofessional manner (e.g., does not follow professional standards for their industry), then the client taxpayer can report the accounting professional to the IRS, the state board through which the professional is licensed or other relevant agencies. Moreover, the client may sue the accounting professional for malpractice.
Examples of penalties and interest
Federal
The following potential federal penalties might occur if there are issues with individual income tax returns and payments to the IRS:
Failure to file penalty: This applies when a taxpayer doesn't file a tax return by the deadline (including if the return was filed after the original deadline without a valid extension filed).
The penalty is 5% on the unpaid taxes for each month (or part of a month) after the deadline. The penalty cannot exceed 25%. If there's both a failure to file and failure to pay penalty, then the failure to file penalty is reduced by the amount of the failure to pay penalty. The result is a combined penalty of 5%, levied each month (or part of a month) on the unpaid taxes until the balance is paid.
Failure to pay penalty: This applies when the taxpayer has filed but hasn't paid the taxes owed by the deadline. Filing extensions do not extend the time to pay taxes due; they only extend the filing deadline.
The penalty is 0.5% of the unpaid taxes for each month (or part of a month) that the balance due is not paid. The penalty cannot exceed 25%. If both a failure to file and failure to pay penalty occur, the failure to file penalty is reduced by the amount of the failure to pay penalty, so a combined penalty of 5% is applied each month (or part of the month) to the unpaid taxes.
Interest on underpayment of estimated tax by individuals: This applies when the taxpayer hasn't paid their estimated tax accurately or on time.
Quarterly interest rates on underpayment of estimated quarterly taxes in 2022 are as follows:
- 1st quarter: 3%;
- 2nd quarter: 4%;
- 3rd quarter: 5%;
- 4th quarter: 6%.
Interest on unpaid tax liabilities penalties: Quarterly interest rates applied until unpaid balances, including penalties, are paid in full for 2022 are as follows:
- 1st quarter: 3%;
- 2nd quarter: 4%;
- 3rd quarter: 5%;
- 4th quarter: 6%.
State and local
The penalties and interest applied at the state and local level will depend on the jurisdictional laws and tax code.
Please note: Sometimes a filing is due to one government agency, but the penalty may be due to a different government agency. An example of this is the annual or biannual filing of the statement of information with the California Secretary of State. If that filing is late, there is a penalty of $250 due to the California Franchise Tax Board (the agency to which California income taxes are filed and paid) rather than the California Secretary of State office.
Requesting waivers or abatements
To request a waiver or abatement of a penalty, the accounting professional or taxpayer must typically submit a signed letter to the agency issuing the penalty. The letter should specify the penalties and provide reasons for why they should be abated. The letter must be signed by either the client taxpayer or their accounting professional to whom they've granted power of attorney.
An additional option for reducing penalties is to set up a payment plan with the government agency owed money from the client or taxpayer. The taxpayer must meet the agency's qualification criteria to be approved for a payment plan.
It's important that all written responses (from the taxpayer or their accounting professional) to notices include reference to:
- The notice letter being responded to;
- The notice date;
- The taxpayer's name and tax identification number; and,
- The tax year.
Qualifying reasons for penalty relief
A penalty may be removed or reduced when the client or taxpayer has reasonable cause and good faith, which are determined on a case-by-case basis.
Reasons that qualify for relief depend on the type of penalty owed and the laws of the government agency. Some government agencies have a tax code for abatement of penalties when it's a taxpayer's first time receiving a penalty. To determine if it's applicable to a client, review the related tax code for the government agency that has issued the penalty.
Reasonable cause doesn't apply to certain penalties, such as those initiated for underpayment of estimated tax.
Typically, the following situations do not qualify as reasonable causes that will result in penalty forgiveness:
- Reliance on a tax professional;
- Lack of knowledge;
- Mistakes and oversights; or,
- Lack of funds.
Ramifications of failing to pay penalties and associated fees
If the penalty, interest or balance due are not paid, then the federal or state governments can put liens on the taxpayer's property and tax payments or refunds to other government agencies. The client or taxpayer would be notified about the lien by notice, a letter sent by traditional mail, from the government agency to which the filing or payment is due to and/or the bank directed to divert the payment. The notice will contain critical information about the type of lien and the methods for contacting the government agency's collection department to respond to the notice. Typically, the accounting professional or the taxpayer may contact the collection department by mail, phone, fax or online.
Usually, due to time sensitivity, the best way to respond to the notice of a lien is to contact the agency by telephone, so they can put a hold on the account. A hold means the taxpayer will temporarily stop being notified of the lien, and collection actions also will temporarily cease as the agency reviews the taxpayer's response to the notice of lien. The agency may request a follow-up letter to request the removal of the lien from the taxpayer's account. The format for the letter requesting removal of the lien will be the same as for letters requesting abatement or waiver of penalties.
Details matter
It's critical that accounting professionals ask their clients to share the tax penalty and lien notices they've received from government agencies. That will ensure they have the necessary facts to determine if a penalty can be waived, abated or appealed, or if a lien can be prevented or retracted.
