Money Talks News may earn commission or revenue through links in the content below. Our editorial team independently selects all products. Compensation does not influence our recommendations.
Martha Stewart just put a price tag on her legal ordeal: “about a billion dollars.”
That’s how much Stewart, 85, says it cost her, according to Fortune’s account of her interview on MasterClass’s “Other People’s Business” podcast. “The lawyers took me to the cleaners, and they were horrible,” she said. (1)
Here’s the part that should stop you cold.
Fortune notes that the stock sale at the center of it all, her December 2001 sale of ImClone Systems shares, avoided a loss of roughly $45,000. Prosecutors never convicted her of insider trading.
In 2004, a jury found her guilty of conspiracy, obstruction and lying to federal investigators about the sale. (1)
I’ve been a CPA since 1981, and I read it a little differently than she does. The lawyers weren’t the real cost. The cover-up was. The original problem was small. What came after it wasn’t.
Ordinary retirees can stumble into a smaller version of the same thing with the IRS. A modest tax mistake gets ignored, hidden or put off until later, and the penalties grow.
An honest error can cost you a 20% penalty on the underpaid tax. (2) Fraud costs 75%. (3) Not filing at all runs 5% a month, up to 25%. (4)
Here are five ways a small tax problem snowballs — and how to stop it while it’s still small.
1. An honest mistake can cost 20%, not your life savings
Forgot to report a 1099 from a bank account? Misread a form? If the IRS sees negligence or a substantial understatement, that can trigger an accuracy-related penalty of 20% of the underpayment tied to it. (2)
For individuals, a substantial understatement means you understated your tax by 10% of the correct tax or $5,000, whichever is greater. (2)
Twenty percent stings. But it’s survivable, and it’s the price of an honest error, not a dishonest one.
2. Hiding it can nearly quadruple the penalty
Here’s where the lesson from Stewart’s case — the cover-up costing more than the original problem — kicks in. To be clear, her case had nothing to do with taxes. But under federal law, if any part of an underpayment is due to fraud, the penalty is “75 percent of the portion of the underpayment” attributable to fraud. (3)
That’s 75 cents on top of every dollar of tax you tried to dodge — before interest. Compared with the 20% honest-mistake penalty, it’s almost four times as much.
When you discover a mistake, you have a choice between those two numbers. Choose the smaller one.
3. Not filing at all is the most expensive kind of silence
If your income dropped or you’re afraid of what you owe, it can be tempting to just not file. Bad idea.
The failure-to-file penalty is 5% of the unpaid tax for each month or partial month the return is late, up to 25%. (4)
There’s a second cost people don’t see.
Normally, the IRS tells you to keep records for three years. If you leave out income that’s more than 25% of the gross income shown on your return, it’s six years.
If you don’t file, or file a fraudulent return, the IRS says to keep records indefinitely. (5) In plain English: if you never file, that paperwork never goes in the shredder.
If you already owe and the letters are piling up, don’t wait for them to stop on their own. They won’t. If you’re behind with the IRS and penalties and interest are adding up, you don’t have to face it alone. Compare your top tax relief options now to find expert help.
Quick aside — most internet financial advice comes from people who weren’t alive during the last recession. I’ve been writing about money for more than 35 years. Want rock-solid advice? Sign up for the free Money Talks Newsletter. Takes 10 seconds. No fluff. No spam.
4. A retirement-account version of the trap: a missed RMD
If you miss a required minimum distribution from your IRA or 401(k), the amount you didn’t withdraw may be hit with a 25% excise tax. (6)
But the IRS also gives you a reason to come clean fast: that tax drops to 10% if you correct the miss within two years. (6)
Same lesson as above. The fast fix is cheaper than the slow one. If you catch it, take the distribution, then talk to a tax pro about reporting it properly.
If you’re juggling several accounts and RMDs are starting to feel like a part-time job, it may be time for help.
SmartAsset offers a free matching tool that connects you with up to three fiduciary advisors in your area. They can help with everything from investment advice to Social Security claiming strategies.
The questionnaire takes about 10 minutes and asks for a phone number near the end — Provide it, but you control whether and when you respond to anyone. SmartAsset matches; it doesn’t give advice. Find a fiduciary advisor
5. A clean record can buy you a break
If you’ve been a good taxpayer, the IRS may cut you some slack. Its first-time abatement policy can remove failure-to-file, failure-to-pay and failure-to-deposit penalties. (7)
To qualify, you generally need a clean history: the same type of return filed on time for the prior three years, and, with narrow exceptions, no penalties in that period other than the estimated-tax penalty. (7)
That’s one more reason to keep your record clean and fix problems quickly. A good history is worth money.
My honest take
Stewart’s comeback is real, and I admire it. But the takeaway for the rest of us isn’t about lawyers or insider trading. It’s this: the first mistake is often cheap. The second one — the one you make trying to hide the first — is where the money goes.
With the IRS, honesty isn’t just the right policy. It’s the cheapest one.
Sources: 1. Fortune; 2. IRS (Accuracy-Related Penalty); 3. Cornell Law School Legal Information Institute (26 U.S. Code § 6663); 4. IRS (Failure to File Penalty); 5. IRS (How Long Should I Keep Records?); 6. IRS (RMD FAQs); 7. IRS (First-Time Abatement)
Add a Comment