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Are IRS Penalties Tax Deductible?

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The US tax code does not allow taxpayers to deduct penalties assessed by the Internal Revenue Service (IRS). IRS penalties are typically assessed for violation of tax laws, such as misreporting income or claiming false deductions or tax credits. The IRS typically assesses penalties along with interest on the balance owed by a taxpayer, and this interest is not tax-deductible.

Key Takeaways

  • Taxpayers cannot deduct IRS penalties on their tax return.
  • Penalties are commonly assessed for a failure to file or pay and for dishonored checks.
  • Penalties vary according to the type of violation and may accrue until the account is fully paid or until the taxpayer enters into an approved payment plan.
  • Extensions filed via a Form 4868 extend the tax filing deadline, but it does not extend the deadline to pay income taxes.

IRS Penalties

Fines and penalties a person owes to the government for violating local, state, and federal laws are never deductible. According to the IRS, the goal of its penalties is to discourage illegal activity related to federal taxes. Penalties also discourage people from neglecting their obligations to file and/or pay. The IRS typically sends a notice to a person after a tax audit and assesses both penalties and interest on any underpaid amounts.

Most often, penalties are assessed for dishonored checks, or for failing to file your tax return by the required due date, failing to pay the full amount of taxes owed by the due date, or failing to pay the proper amount of estimated taxes. Penalties vary according to the type of violation. For example, a penalty of 5% of the tax required is assessed when the taxpayer fails to file on time, and it is charged each month that the return is late, up to five months. The IRS assesses a 0.5% penalty on taxes not paid by the tax filing due date, which is generally April 15. “If both a failure-to-file and a failure-to-pay penalty are applicable in the same month, the combined penalty is 5% (4.5% late filing and 0.5% late payment) for each month or part of a month that your return was late, up to 25%,” notes the IRS website. 

Please note, in 2020 the tax filing deadline for 2019 income taxes was extended from April 15, 2020, to July 15, 2020, due to the coronavirus pandemic.

Although taxpayers are not allowed to deduct penalties, they may qualify for relief for extenuating circumstances. If approved by the IRS, all or a portion of the penalty may be relieved. However, interest still accrues until amounts owed are fully paid.

Failure-to-pay penalties are assessed on the tax owed after the due date, for each month or partial month, until the taxpayer’s account is resolved.  The IRS allows installment agreements to pay off the outstanding balance and to stop the assessment of failure-to-pay penalties.

Coronavirus Relief and Tax Filing Deadline Extension

In 2020, the tax filing deadline for 2019 income taxes was extended from April 15, 2020 to July 15, 2020 due to the coronavirus pandemic. This new deadline also included an extension for the final 2019 estimated tax payments that were originally due on April 15, 2020. Penalties and interest on unpaid taxes do not begin to accrue until July 16, 2020. 

As always, taxpayers have the option to extend their tax filing deadline beyond July 15, 2020 by filing an extension using Form 4868. However, an extension on filing your return does not extend the deadline for your tax payments. 

Legal Fees Deductibility

According to IRS Publication 529, legal expenses incurred in attempting to produce or collect taxable income or paid in connection with the determination, collection, or refund of any tax are no longer deductible. You can deduct expenses of resolving tax issues relating to profit or loss from your business (Schedule C), rentals or royalties (Schedule E), or farm income and expenses (Schedule F) on the appropriate schedule. However, expenses for resolving nonbusiness tax issues are miscellaneous itemized deductions and are no longer deductible. 

Other Penalties

While IRS penalties cannot be deducted, other penalties related to business activities can be deducted by companies on a tax return. For instance, penalties paid by a manufacturing company due to nonperformance on a construction contract are typically deductible as a business expense. 

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