1. Personal Income Tax Guide: Introduction
  2. Personal Income Tax Guide: Basic Concepts
  3. Personal Income Tax Guide: Documentation And Records
  4. Personal Income Tax Guide: Moves To Make Before December 31
  5. Personal Income Tax Guide: Moves To Make Before April 15
  6. Personal Income Tax Guide: 6 Overlooked Deductions And Credits
  7. Personal Income Tax Guide: Common Filing Mistakes
  8. Personal Income Tax Guide: Avoiding Nasty Surprises
  9. Personal Income Tax Guide: Conclusion
By Ken Clark

The last thing any taxpayer wants to find in their mailbox is a letter from the IRS, unless of course it holds their refund check. That's why, for many taxpayers, filing their return involves a prayer, a rabbit's foot, or an attempt to store up some good karma.

Luckily, avoiding nasty IRS surprises doesn't have to be a meta-physical experience. In most cases, it simply requires a "heads up" attitude where taxpayers know the details of their situation (be it good or bad) and take a proactive approach to solving them. (For more information on this, see Cut Your Tax Bill.)

Get Started As Early As Possible
When it comes to taxes, perhaps the single best piece of advice out there may be, "don't wait until the last minute". April 14 is the wrong time to realize that you don't understand the rules for the mortgage deduction or that your local computer store is sold out of tax preparation software. Likewise, the only thing you may hear from your CPA is laughter if you call on April 1 hoping to book your tax appointment. (To read more about deductions and when to file, see Deducting Your Donations and Don't Put Off Your Year-End Plan.)

By starting early, you'll not only ensure that your tax preparation and filing experience are low-stress, but you'll also give the IRS ample time before April 15 to send back a return with a major error. If you're entitled to some money back, you'll also be much more likely to receive a quick refund if you file before the April 15 rush. As a general rule, many experts recommend trying to file your return by the end of February. (For more on what to do to be prepared early, read Money Saving Year End Tax Tips.)

Estimating and Avoiding Penalties
While the stiffest of IRS penalties, a jail cell, is reserved for people who intentionally try and defraud the system, that doesn't mean that the IRS is overly lenient on people who make innocent mistakes. In fact, the IRS is more than happy to assess double-digit interest rates on unpaid balances and substantially late filers.

To add insult to injury, the IRS has one of longest reaches of any creditor, with a unique ability to garnish wages and seize assets to pay off your debt to them.

Because of this, taxpayers should do everything they can to avoid penalty situations. If a penalty is unavoidable, then a taxpayer should get a firm handle on how much they owe and how the balance will grow, so that they're not caught off-guard down the road.

Here's a breakdown of the major penalty categories and their calculations:
  • Failure to File - This is the most easily avoided penalty, since a taxpayer can still file their return even if they are unable to pay an amount due. The penalty for this infraction is 5% of the amount due on the return, per month, up to a maximum of 25%.

  • Failure to Pay - While most people might assume that the IRS sticks taxpayers with severe penalties for failing to pay on an amount owed, it is actually one of the most lenient penalties. It turns out that the IRS is far more understanding of people's hardships than it is given credit for. The penalty is a reasonable 0.5% per month up to 25% of the amount due. Again, it's worth pointing out that the IRS penalizes more for failing to file a return than for filing a return but not being able to pay the balance!

  • Accuracy Penalty - Most often, when the IRS finds an error on your return or uncovers a mistake in an audit, they give the taxpayer the benefit of the doubt as to their intent. That doesn't mean though, that there's not a penalty for doing your math incorrectly. Unlike the "Failure to File" or "Failure to Pay" penalties that can accumulate over a couple of months, the "Accuracy" penalty is an immediate 20% of the under-calculated amount. Naturally, the easiest way to avoid this penalty is to double-check your math at least twice. (In the event of an audit, see Avoiding An Audit and Surviving the IRS Audit.)

  • Fraudulent Return - When the IRS feels like a taxpayer has gone above and beyond in their efforts to minimize their tax burden by using such questionable techniques as deliberately hiding income or knowingly inflating deductions, they slap them with the stiffest penalty possible. The penalty for fraud is an immediate 75% of the amount of the under-calculation due to the fraud. Additionally, the IRS can and does pursue jail time for tax cheats. Needless to say, the worst tax strategy is dishonesty, since the downside often involves sharing a jail cell.
If You Owe More Than You Can Pay
As mentioned before, the IRS is surprisingly understanding of taxpayers who find themselves in a financial bind. It's actually in their best interest to minimize their collection costs by setting up some kind of payment plan that encourages you to pay what you can instead of burying your head in the sand and forcing them to start a collection action.

While the Offer In Compromise program (where IRS debts are settled for pennies on the dollar) appears to be winding down due to overuse by taxpayers, the IRS is more anxious than ever to set up "installment" payment plans for balances owed. These plans can provide taxpayers with a manageable monthly payment and cease IRS collection actions.

Of course, setting up an IRS installment plan is not automatic. For balances under $25,000, taxpayers can go online and set up an Online Payment Agreement. Taxpayers owing more than $25,000 must complete and mail both Form 9465 and Form 433F to be considered for an installment plan.

Last but not least, taxpayers who owe a balance but have yet to enter into an agreement, should be on the look out for tax amnesty opportunities. These programs, which are usually offered by individual states, allow taxpayers to pay off their debts with much of their penalties and interest waived. But don't hold your breath for these programs in lieu of other repayment options, since years may pass between when a state or local agency offers amnesty to delinquent taxpayers. (For further reading on taxes visit our Income Tax Special Feature.)

Personal Income Tax Guide: Conclusion
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