- As of 2011, most tax penalty payments are not deductible off of your next year's taxes. The U.S. Congress specifically ruled that these expenses are not deductible; if they were, there would be no incentive for taxpayers to pay on time and avoid penalties, as paying penalties would provide a tax break in the following year.
- Many lenders assess penalties for paying your mortgage ahead of time. If the mortgage is paid in full, you may deduct these penalties off of your taxes, according to IRS Publication 936. Report this penalty as mortgage interest when you itemize your deductions on Schedule A of your 1040 return. You cannot claim this deduction if you roll prepaid funds over into a refinanced mortgage, as you have transferred the mortgage rather than paid it in full.
- Penalties for early withdrawal of funds from retirement accounts are not tax deductible. However, in some cases you may be exempt from paying these penalties. If you become disabled and cannot work, you do not have to pay tax penalties on early withdrawal of retirement funds. The funds are also not taxable if the withdrawal is made to a beneficiary after your death, or if you withdraw less than you are entitled to in deductions for medical expenses for the year.
- To avoid tax penalties, pay your taxes before April 15 of each year. If you are self-employed, you must pay enough estimated tax throughout the year to avoid a penalty for underpayment of tax in April. Avoid withdrawing funds from your retirement account unless you have no other means of resolving a financial crisis to avoid retirement tax penalties. When in doubt, consult a tax advisor to ensure you will not receive a tax penalty.
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