Taxpayers who do not timely file their returns or timely pay their obligations will be subject to penalties not only at the federal level with the IRS, but also at the state level with the Minnesota Department of Revenue (state).

The state assesses different penalties for taxpayers who are individuals versus businesses. The penalties vary in both severity and in the dates on which returns or payments are due.

Individuals

The penalty for an individual filing a return late is 5% of the unpaid tax. The taxpayer is also subject to an additional delinquency penalty. The delinquency penalty is 5% of the unpaid tax and is assessed if the taxpayer provides no response within thirty days of the state’s demand for an unfiled return. This puts a premium on communicating with the state.

The penalty for paying the tax late is 4% of the unpaid tax. If the taxes are not paid within 180 days from the due date, then the state can assess an additional 5% of the unpaid tax. When the two penalties run together, the individual taxpayer is subject to a total assessment of 19% of the unpaid tax. These are stiff penalties. Although, from a practical standpoint, even though the actual deadline for filing and paying your taxes is April 15, the state will not assess penalties until after October 15. Essentially, this allows the taxpayer a penalty-free grace period to file their return and pay their tax obligation.

Businesses

The penalty for a business filing a late corporate franchise, mining, fiduciary, estate, partnership, or S corporation tax return is 5% of the unpaid tax. The business is also subject to the delinquency penalty of 5% of the unpaid tax. However, the taxpayers filing fiduciary, estate, partnership, or S corporation tax returns receive an automatic six month extension to file their returns and avoid the late-filing penalties. The penalty for a business paying the tax late is 6% of the unpaid tax. If the business does not pay the taxes when it files its return, the state will assess an additional penalty of 5% of the unpaid tax. Whether intentionally or not, the state is making it advantageous for a business to temporarily refrain from filing its return until the business can remit full payment with its delinquently filed return.

Sales, withholding, and MinnesotaCare taxes have different, and often times more severe, penalties for late filing and late payment. The penalty for filing a return late is 5% of the unpaid tax with the delinquency penalty of 5% of the unpaid tax. The penalty for late payment is assessed thirty days after the due date of the payment and is 5% of the unpaid tax. The state can assess this 5% penalty for every thirty-day period that the tax remains unpaid, up to 15% of the unpaid tax. Therefore, making appropriate estimated payments allows businesses with these obligations to avoid being subject to penalty. http://www.irs.gov.

Penalty Abatement

The state, like the IRS, will abate penalties when the taxpayer can demonstrate that he or she had reasonable cause for failing to timely file the return or pay the obligation. Reasonable cause exists when the taxpayer can show that the circumstances that caused the untimely performance were beyond the taxpayer’s control. Some examples of reasonable cause are death or serious illness of the taxpayer or an immediate family member, natural disasters, theft or other criminal activity, or electronic deposit errors on the part of a bank. This is not an exhaustive list. The most important thing to remember when trying to prove reasonable cause is that the circumstances must show that the events were out of the taxpayer’s control.

One major difference between the state and the IRS is that if it is the taxpayer’s first time failing to timely perform, then the state will presume the taxpayer had reasonable cause based upon the taxpayer’s previous good history. However, this presumption can be overcome. If the state believes it would be inequitable to apply this presumption, then the state will not abate the penalties.

More information about state procedures for abating penalties can be found in the MDR Collection Manual and in Revenue Notice #97-01.

Many taxpayers are unable to timely file their returns or timely pay their obligations. When this happens, the IRS will usually assess penalties against the taxpayer. The penalty for filing the return late is 5% per month, up to 25% of the unpaid obligation. The penalty for paying the tax late is .5 % per month, up to 25% of the unpaid obligation. When the two penalties run together, the late filing penalty will be reduced to 4.5% per month, up to 22.5% of the unpaid obligation. These are stiff penalties.

One common reason taxpayers fail to file their return or file their return late is that they do not have the money to pay the tax and they are afraid of what the IRS will do when it receives a return without full payment. They are concerned that as soon as the return is filed, the IRS will begin pursuing them by levying their bank accounts or their wages. This can happen, but a 25% late filing penalty is a steep price to pay for some additional time to pay the tax. It is usually better for the taxpayer to file the return and, either before or after the IRS contacts them, propose a payment plan or an Offer in Compromise to resolve the obligation. Having filed the return, they have avoided a significant penalty and start their negotiations with a much smaller liability.

Unfortunately, there are many instances when a taxpayer simply cannot file the return or pay the tax on time. Late filings and late payments are often the result of difficult and stressful situations which overwhelm the taxpayer. The IRS recognizes this, and will abate the penalties when the taxpayer can demonstrate that he or she had reasonable cause for failing to timely file the return or pay the obligation.

To prove reasonable cause, the taxpayer must demonstrate that he or she exercised ordinary business care and prudence but was still not able to comply with the filing and payment requirements. The IRS will take into account all the facts and circumstances of the taxpayer’s situation. Internal Revenue Manual (IRM) 20.1.1.3.1.2.

The IRS provides examples of when a taxpayer has reasonable cause in IRM 20.1.1.3. These are only examples. They are instructive, but they are not the only circumstances that amount to reasonable cause. We encourage taxpayers to ask the IRS to abate the penalties in any situation where they believe they had reasonable cause for the late filing or late payment.

A taxpayer may ask for a penalty to be abated by filing a Form 843. The instructions for this form and more information about the penalties are available at the IRS website, www.irs.gov.

The Minnesota Department of Revenue (MDR) has similar penalties and procedures for abating those penalties. Information about the MDR procedures can be found in the MDR Collection Manual. We will address the state’s version of these penalties in our next posting.