The 3 Most Confusing IRS Tax Penalties


by Chloe Anagnos, Tax Revolution Institute, ©2017

Committing a foul on your taxes will cost you big time with the IRS, but who’s really to blame with such a confusing rule book? (Photo: Don’t Mess with Taxes)

(Jan. 24, 2017) — The federal tax code is 187 times longer than it was a century ago, according to the accounting firm Wolters Kluwer, CCH, which has analyzed it since 1913.

Since 1984, when the tax code was 26,300 pages, it has nearly tripled to the length it is today.

That rapid growth does not come without consequences to the taxpayer. During these decades, the tax code has been written in a way to direct and encourage people into buying hybrid vehicles, buying health insurance, adopting children, and other social and economic objectives, according to the Tax Foundation’s chart book, “Putting a Face on America’s Tax Returns.”

With those consequences comes the potential to be slapped with some of the most confusing Internal Revenue Service tax penalties.

(1) 401(k) Plans

Want to pull some cash out of your 401(k) plan to cover bills? Better think twice. According to author and financial expert John F. Wasik, any withdrawals made before age 59 and a half are subject to a 10 percent IRS penalty — plus any income taxes due.

For example, if you are in the 25 percent tax bracket, a $5,000 early 401(k) withdrawal will cost $1,750 in taxes and penalties. There are some exceptions to early withdrawals, like using the money to pay for medical bills, but Uncle Sam isn’t that lenient.

Penalties will also follow if you incorrectly transfer your 401(k) over to an IRA, leave a job before you are fully vested in your retirement plan, or if you take out any kind of 401(k) loan.

(2) Solar Panels

The Environmental Protection Agency and the Department of Energy offer tax breaks to those who install and use solar panels on their homes. Solar installations can qualify you for a credit equal to 30 percent of your total cost, which is only available through the end of 2019. After that, the percentage steps down each year and then stops at the end of 2021.

A 30 percent credit is pretty significant, but unfortunately for taxpayers, there are a lot of confusing exceptions. You can’t claim the full credit for installing solar power on rental properties or vacation homes that you own. It only can be applied to a home that you live in for a full financial year at a time.

Moreover, some states offer credit for installing solar panels while others don’t — something that a San Diego man learned the hard way after he found out that he owed about $8,000 to the IRS and the state of California. The California Public Utilities Commission is currently warning consumers about high pressure, misleading solar salespeople who make false promises of tax breaks in order to sell their product.

(It should be noted that I attempted to find out what the actual tax credit stipulations are for solar panels on a state by state basis only to be met with an error page on the Energy Department’s website.)

(3) Healthcare

Since the Affordable Care Act took effect on January 1, 2014, most taxpayers are still confused about how the law affects their tax credits and refunds.

The mandate requires that Americans buy health insurance or pay a penalty. To help taxpayers afford coverage, credits were made available for those who purchased insurance through a state or federal exchange.

However, according to H&R Block, 60 percent of taxpayers who enrolled in the marketplace and received the Advance Premium Tax Credit (APTC) must return a portion of the APTC at tax time. The average amount paid back in 2015 was $579, almost $50 more than the 2014 tax season. For taxpayers, it means smaller refunds.

The 2015 financial year was only the second year that (1) the mandate was in place and (2) the second year for calculating the applicable penalty or credit.

H&R Block found that taxpayers were not any more successful at estimating their 2015 income than in 2014. Taxpayers who underestimated their income in order to figure out the credit had to repay a portion of it. Only a whopping 3 percent of taxpayers guessed closely enough to have no impact on their tax return.

Bottom Line

Now is the crucial time for the IRS to simplify the language of the tax code so that taxpayers can file without confusion or fear of being audited. As our executive director says, “no one should fear the IRS if they’ve done nothing wrong.”

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