Dishonored Check Penalty

Paying the IRS with a check or electronic payment that your bank returns does more than leave the tax unpaid. It can add a penalty of its own. The dishonored check penalty is small compared with most IRS penalties, but it can appear alongside other charges when a payment is made close to a deadline. This page explains how it works, how it is calculated, and what to do if the bank was at fault or you had a good reason to expect the payment to clear.

What triggers it

The penalty applies when a check or other form of payment sent to the IRS is not honored by the bank or processor. Pub. 15 notes that any form of payment that is dishonored and returned from a financial institution is subject to the penalty. The cause can be insufficient funds, a closed account, a stop-payment, an error in the account number or a problem on the bank's end.

Businesses can run into this with payroll tax deposits. A bounced deposit means the money did not arrive on time, so the business may face both this penalty and a failure-to-deposit penalty. Individuals see it with balance-due payments or estimated tax payments that fail.

How the penalty is calculated

Examples (hypothetical).

• A $5,000 estimated tax check is returned. The penalty is 2% of $5,000, or $100.
• A $1,250 check is returned. The penalty is 2%, or $25.
• An $800 check is returned. The penalty is $25 (the smaller of $800 or $25).
• A $20 payment is returned. The penalty is $20, the smaller figure.

The penalty is charged on each dishonored payment. If you replace a returned check with another payment and that one clears, you still owe the penalty on the first one.

What happens to the tax itself

A dishonored payment generally does not count as a payment of the tax. The tax stays due, and the other penalties and interest that depend on timely payment can continue to run. That means a returned check on the due date can start the clock for the failure-to-pay penalty at 0.5% a month, while interest accrues on the unpaid tax. Interest on the dishonored check penalty itself starts from the date the IRS sends a notice or assesses it.

If your payment is returned, replace it promptly with a payment you know will clear, and keep a record of the date. If you cannot pay the full amount, an installment agreement is better than risking another returned payment.

How to avoid it

• Pay from an account with a cushion above the amount of the payment, and avoid sending a payment on the day a deposit is expected to arrive.
• Use the electronic payment methods the IRS provides, and confirm that the account and routing numbers are correct before submitting.
• Match payment dates to your bank's cutoff times so a scheduled payment does not draw on funds that are not there yet.
• Review bank alerts. If a payment fails, correct it the same day.
• Keep payroll tax payments in a separate account so other bills cannot overdraw it.

Disputing or requesting relief

The IRS says the penalty does not apply if you paid in good faith and with reasonable cause, believing the account had enough money. To ask for removal, send a signed and dated written statement that explains why, with supporting documents such as bank statements or a letter from your bank or the processing agency. Mail it to the address on your notice.

If your bank returned the payment in error, send a letter explaining that and enclose proof, such as a letter from the bank acknowledging the error. Pay the amount you owe on the tax, but do not include the penalty you are disputing. Have these items ready when you write or call:

1. The notice or letter number and date
2. The penalty name and period shown on the notice
3. Your reasons, listed for each penalty
4. Copies of the returned item, bank statements and any bank correspondence

If you did not receive a notice, you can call IRS telephone assistance. The general steps are in our guide on how to request penalty abatement, and the IRS standards for good faith are described on the reasonable cause penalty relief page. Interest on the penalty is removed if the penalty is removed.

First-time abatement does not apply

The dishonored check penalty is not among the penalties covered by first-time abatement, which covers failure-to-file, failure-to-pay and failure-to-deposit penalties. The route for this one is reasonable cause, or showing that the bank was at fault.

How we can help

We can review the IRS notice, confirm that the payment was applied after it was replaced, check whether other penalties were triggered by the same event, and draft the statement and documents for a relief request. For businesses, we can also review how payroll deposits are funded so a returned item is less likely. The IRS decides each request, and we cannot promise a particular result.

Learn about our payroll services or contact us.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.