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Seven common tax penalties to avoid

The IRS issues almost 32 million penalties a year. Here are the most common tax mistakes and how to avoid them.

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You likely aren’t interested in raising your tax bill, but if you use bad judgment or make a serious error on your tax return, that’s exactly what will happen when the IRS hits you with a penalty.

But hey, at least you won’t be alone: The federal agency imposed almost 32 million civil penalties amounting to $12.4 billion on individual and estate and trust taxpayers in fiscal year 2015. The IRS reduced or forgave fewer than 10% of those penalties, which means it’s not easy to get out of them.

The moral of the story is don’t do anything that could generate a tax penalty. Here are seven common tax blunders to avoid.

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1. Not filing your return on time

If you miss the April deadline and don’t request an extension (which must be done by the April deadline, too), you’re probably on the hook for a late-filing penalty. That will be 5% of the amount due for every month or partial month your return is late. The maximum penalty is 25% of what’s outstanding.

2. Not paying your taxes on time

Filing a return on time and paying your taxes on time are two different things, and they carry different penalties. So if you don’t fork over the dough you owe by the April deadline (even if you got an extension on filing your returns) you will get hit with more penalties.

First comes interest. It starts accruing on your outstanding balance on the day of the April deadline — again, even if you got a filing extension. The current rate is 4%, compounded daily (the interest rate can change quarterly).

The second hit is the late-payment penalty. It runs 0.5% of your unpaid taxes for each month your outstanding taxes are unpaid. The maximum penalty is 25%. You might be able to get out of this penalty if you can show reasonable cause, but you’ll need to attach a written explanation to your return.

You can pay your tax bill in installments, but if you need more than 120 days to pay, you’ll also get hit with a $120 fee (or $52 if you agree to a direct debit payment plan).

3. Filing really, really late

If your return is late by more than 60 days, you will probably have to pay a tax penalty of either $135 (adjusted for inflation) or what you still owe, whichever is smaller. The IRS also might look the other way if you can give a reasonable explanation for not filing on time, but again, you’ll need to attach a written statement to your return.

If you really drag your feet or decide to go off the grid, the IRS might also file what’s called a substitute return. Basically, the agency prepares a return for you, using information it gathers from other sources. The problem here, of course, is that the IRS is guessing — it likely won’t consider the credits and deductions you might qualify for. Then it will send you a tax bill that might be higher than what you would have paid if you had just done the calculations yourself. That bill will probably include interest and penalties, too.

4. Owing more than you think you do

This may happen after your file your return. If the IRS audits you and decides you didn’t pay enough in taxes, it will send you a new bill. And if you don’t pay the extra taxes in 21 days, you’ll face a penalty of 0.5% for each month (or partial month) they remain overdue. If the IRS decides you understated things too much (you were off by 10% or $5,000, whichever is higher) or that you negligently disregarded the tax rules, it can hit you with a penalty of 20% to 40% of the increase in tax. Sometimes you can get those penalties abated, but prepare to wrangle with the IRS.

5. Not buying health insurance

Not having health insurance can cost you: For tax year 2016, you’ll have to pay a penalty equal to the higher of either 2.5% of your household income or the sum of $695 per uninsured adult and $347.50 per uninsured child under 18. The penalty caps out at $2,085 or the annual premium for the national average price of a Bronze plan on the marketplace. If you were covered part of the year, the fee is prorated for each month you or your dependents didn’t have coverage.

6. ‘Forgetting’ about that foreign account

If you have one or more financial accounts outside of the United States that exceed a combined $10,000 value (for even just one day of the tax year) and purposely don’t report them, the IRS could take 50% to 100% of your balance if it catches you. The penalties are lower if the IRS thinks you did not hide the money on purpose.

U.S. citizens and resident taxpayers have to report money or property they transfer or receive through a foreign trust. If you get caught, you could face penalties of up to 35%.

If the value of an individual’s overseas accounts was more than $50,000 on the last day of the tax year or more than $75,000 at any time during the year (or $100,000 and $150,000 for married couples), you may also need to file IRS Form 8938, which comes with its own set of penalties running into thousands of dollars.

7. Filing a frivolous tax return

If you want to write the IRS a nice letter stating that you think it doesn’t have the authority to tax you and therefore you owe nothing, think again. The IRS can assess a $5,000 penalty for filing frivolous returns, and you could be subject to many of the late-filing and late-payment penalties already mentioned. Plus, tax courts can add their own penalties for filing frivolous returns or frivolous court petitions.

If you decide to see what you can get away with and file a fraudulent return, you’ll face a penalty of up to 75% of your underpaid taxes — on top of everything else. If you’re caught investing in or promoting abusive tax schemes, you could rack up $250,000 in fines and go to prison for up to five years.

And remember: Even though the federal government only has six years to charge you with tax evasion, it has a decade or more to collect those penalties.

Tina Orem is a staff writer at NerdWallet, a personal finance website. Email:torem@nerdwallet.com.

This article first appeared at NerdWallet.

The Christian Science Monitor has assembled a diverse group of the best personal finance bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link in the blog description box above.

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