Are IRS Penalties Tax Deductible?

The U.S. 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.

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. The IRS typically sends a notice to a person after a tax audit and assesses both penalties and interest on underpaid amounts.

IRS Publication 535 states that a taxpayer is eligible to deduct various legal fees and expenses associated with resolving the tax problem for which the IRS assessed penalties. Court fees can also be deducted on a tax return subject to the 2% limit promulgated by the IRS. According to IRS Publication 529, the 2% limit states that legal fees for tax advice can be deducted if a taxpayer itemizes his deductions, but these legal fees fall under the 2% limitation on miscellaneous itemized deductions.

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.