South Carolina imposes a number of civil tax penalties that are similar to those imposed under the Internal Revenue Code (the “Code”). South Carolina’s civil tax penalties, while similar in some respects, are not the same as the Code’s civil penalties. The following is a summary of South Carolina’s civil tax penalties:
1. Failure to file (late filing) – 5% of the amount due is levied per month or fraction thereof, up to 25%.
2. Failure to pay (late payment) – 0.5% of the amount due is levied per month or fraction thereof, up to 25%
3. Negligence or disregard – 5% of the underpayment or negligently claimed refund, and 50% of the interest due, is added to the tax. If an underpayment is due to fraud (see below), 75% of the portion of the underpayment attributable to fraud, and 50% of the interest due. “Negligence” includes a failure to make a reasonable attempt to comply with the law, and “disregard” includes careless, reckless, or intentional disregard.
4. Substantial understatement – 25% of the underpayment attributable to either a substantial understatement or substantial valuation misstatement. A substantial understatement exists when the understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000. There is a substantial valuation misstatement if the value of property or the adjusted basis of property is 200% or more of the amount determined to be the correct amount of the valuation or adjusted basis. The substantial understatement penalty does not apply when the fraud penalty is imposed.
5. Civil fraud – 75% of the portion of the underpayment attributable to fraud, and 50% of the interest due, is added to the tax. The failure to file and failure to pay penalties are not assessed when the fraud penalty is assessed.
6. Estimated tax – South Carolina follows the Code.
7. Frivolous return – $500 for the first filing, $2,500 for the second filing, and $5,000 for each subsequent filing. This penalty is in addition to all other penalties.
8. Failure to maintain books and records – up to $500 penalty imposed for failing to maintain books and records.
The failure to file, failure to pay, substantial understatement, and civil fraud penalties are all considered “additions to tax,” which means that interest is also due on the penalties. The negligence penalty is also an “addition to tax”, but is particularly punitive with its own special interest rate of 50% of the total interest due and not simply an addition of the otherwise applicable interest on the tax itself. Calculating the negligence penalty presents computational difficulties and is a historical relic of penalties imposed under the Code prior to 1989.
Taxpayers may avoid penalties if it is shown there was reasonable cause for the underpayment and that the taxpayer acted in good faith. The terms, “reasonable cause” and “good faith”, are defined in the same manner as those terms are generally defined in the Code. While taxpayers generally have the burden to prove a tax assessment is correct, South Carolina courts have held the South Carolina Department of Revenue (“DOR”) bears the burden of proving that a penalty applies. If a taxpayer has substantial authority for a position or makes a qualified disclosure, the substantial understatement penalty does not apply.
Taxpayers faced with penalties asserted by DOR have a number of options to challenge the penalties. DOR has published guidance concerning full and partial administrative penalty waivers. The penalties can be challenged during an examination, on administrative appeal, or before the South Carolina Administrative Law Court. Taxpayers are strongly encouraged to consult with an experienced tax practitioner when challenging penalties.