The IRS has a lot of penalties. In fact, they have a handbook dedicated to penalties. Luckily, most taxpayers won’t face most of them. There are two that the average taxpayer can find added to their balance due and I get asked about them a lot this time of the year. Clients want to know about the penalties they will face if they don’t file their return or can’t pay their tax. And, of course, they also want to know about the interest the IRS will charge.
First, it’s important to understand that these penalties and interest are based on what you owe. If you have tax refund, then your return can be late and you don’t get penalized. You’ll just lose the refund if you wait too long to file the return.
Failure to File – This is a killer of a penalty. It is 5% a month or part of month until you reach a maximum of 25%. There is also a minimum penalty of $135 or 100% of the tax if you’re over 60 days late filing your return. That is just for not filing the return on time.
Failure to Pay – When you don’t pay your balance due you trigger this penalty. It’s a half of 1% a month up to a maximum of 25%. If you are also accruing the failure to file penalty, the maximum rate between the two is 5% a month. Also the half percent goes to 1% if you don’t pay your balance due within 10 days of receiving a notice to levy.
If you file an extension, you are still expected to estimate your balance due and pay that by April 15th . If you don’t pay at least 90% of the tax, you can be hit with the failure to pay penalty.
Interest – As if the penalties aren’t bad enough, the IRS will also add interest to your debt. The basic rate is the current federal short term rate plus 3%. It changes quarterly and for April 2015 3.48% (0.48% plus 3%). Interest is compounded daily. And yes, interest is charged on the penalties and interest and added to your balance due.
How does it work? Let’s say you owed $1,500 on your 2013 tax return. It was due April of 2014 and you didn’t file the return until October 15, 2015. How much will you owe after 18 months? According to the program I use to calculate interest and penalties, TaxInterest, you will owe $1,989.42 (You didn’t think I would do this by hand? No way) The breakdown is:
- Balance due: $1,500.00
- Interest: 46.37
- Penalty interest: 15.55
- Failure to file: 337.50*
- Failure to pay: 90.00
- Total: 1,989.42
- * Since the failure to file and failure to pay penalties ran simultaneously for 5 months with a maximum of 5% a month the total failure to file penalty is 22.5%.
The IRS will abate (reduce or drop) the penalties for just cause. When you receive a notice, send in a letter explaining the circumstances. There are also times, such as natural disasters, when they will give a blanket reprieve to taxpayers in that area. If you don’t pay all your tax, interest and penalties at one time, the IRS applies your payments to the tax first and the interest and penalties continue to grow.
States all have their own interest and penalties on income taxes not paid on time. In Kansas, the interest is 4% a month. We only have one penalty which is 1% a month to a maximum of 24%.
It’s to your advantage to get your income tax paid as soon as possible. It might be financially advantageous to get a loan when you fact in the penalties. Even if you can’t pay the tax, get the return filed and stop the failure to file penalty. If you look at the example, that penalty was twice the combined interests and failure to pay penalty for 18 months.