Are Late Fees on Corporate Tax Deductible Expenses?

Every corporation can be charged late fees, or penalties, for filing or paying its taxes late. These penalty charges can substantially increase federal, state and local income tax bills for small businesses that miss certain payment or filing deadlines. And to deter consistent disregard of deadlines, corporate tax penalties aren't treated as deductible business expenses – though some related costs are.

Corporations that fail to file a complete and accurate tax return with the Internal Revenue Service, as well as with the state and local tax agencies that also require returns, by the deadline can get hit with a 5-percent penalty for each month the return is late. This penalty is calculated on a corporation's unpaid taxes and maxes out at 25 percent. A second monthly penalty – equal to one-half of one percent of the unpaid corporate income tax bill – can also be charged for paying late, regardless of whether the tax return is timely filed or not. And if your corporation has to pay both penalties for the same period, the added expense can really deplete the business's profits, leaving less money available for shareholder dividends or to grow the company.

The IRS doesn't allow corporations to deduct these penalties or other income tax-related late fees on their 1120 forms – the federal corporate income tax return form – like it does for most other ordinary and necessary business expenses. And since federal income taxes are never deductible on state and local corporate returns, no tax breaks are available for related penalties either.

Your corporation can, however, deduct the taxes it pays to state and local governments on Form 1120. But for the same reason that the federal government doesn't treat its own late penalties as deductible business expenses, corporations can't include the late penalties they pay to state and city tax authorities in their deductible taxes. In essence, business expenses must be ordinary and necessary to be deductible; however, corporate tax penalties aren't only unnecessary, avoidable and detrimental to businesses, they're also not ordinary – meaning the majority of corporate businesses avoid them by meeting tax deadlines.

If your corporation is ever charged late penalties that are substantial, relative to its earnings, and you dispute its imposition for some reason, the expenses related to defending your business against the IRS or other tax agencies in court are deductible. For example, if you file a case on behalf of the corporation in Tax Court to dispute the underlying circumstances that resulted in IRS penalty charges, attorney fees, court costs and other expenses related to the lawsuit are fully deductible business expenses.