IRS Penalties & Interest

How does the IRS go about applying penalties and interest to taxpayers?

In this article we’ll be discussing the 4 types of penalty charges, and how the IRS goes about applying them.

For clarity: Original Due Date = Generally April 15th for Individual Taxpayers

Extended Due Date = Generally October 15th for Individual Taxpayers

Failure-to-File Penalty

• A failure-to-file penalty is assessed in the instance of a Taxpayer owing tax, but not properly filing their return on a timely basis, including extensions. This penalty is in addition to both the tax due and the interest on the past due tax. It’s calculated at 5% of the tax owed for each month, or part of a month, that the return is late up to five months (or 25%).
  • EXAMPLE – Taxpayer A owes $20,000 in federal tax with the filing of their 20XX tax return. The Taxpayer didn’t file an extension prior to the 4/15 deadline, and simply filed their finalized return on 6/15. In this scenario, the Taxpayer would have a failure-to-file penalty of $2,000 assessed on their 20XX tax return. (($20,000 x 5% = $1,000 per month ($1,000 x 2 months = $2,000).

Failure-to-Pay Penalty

• A failure-to-pay penalty is assessed when a Taxpayer does not make the necessary payment prior to the original due date, even if the Taxpayer also filed an extension. Generally, the Taxpayer will have to pay 0.5% of the actual tax owed for each month, or part of a month, that the tax remains unpaid from the original due date. There’s no cap to the failure-to-pay penalty.
  • EXAMPLE – Taxpayer B owes $10,000 in federal tax with the filing of their 20XX tax return. The Taxpayer filed an extension without making a payment on 4/15. Taxpayer B then paid the $10,000 federal tax payment with the filing of their 20XX return on the extension due date of 10/15. In this instance, the Taxpayer would be charged a failure-to-pay penalty of $300 (($10,000 x 0.5% = $50 per month ($50 x 6 months = $300)).
  • This failure-to-pay penalty also leads into our next topic regarding interest.

Interest Charges

• IRS interest is charged on any unpaid tax (including penalties) from the original due date of the return, up to the date of payment. The rate used is determined and posted every three months (federal short-term rate plus 3%). Interest compounds daily.
  • From the above example – In addition to a failure-to-pay penalty, Taxpayer B will be charged interest on their unpaid tax. As the original due date of the return was 4/15, this is the effective date for interest to begin accruing. The 20XX second quarter interest rate was 4% for underpayments. Using an amortization table, we can determine that the additional interest on the $10,000 tax liability (and $300 failure-to-pay penalty) through 10/15 is $202.56

Late Estimated Tax Payments (Underpayment Penalty)

• If you are subject to quarterly estimated tax payments, then you may be penalized if those estimated tax payments are paid late. Individuals who are commonly required to pay quarterly estimates (which are generally due 4/15, 6/15, 9/15, and 1/15 of the following tax year) can include self-employed individuals, partners in a partnership or shareholders in an S-Corporation, and individuals with investment income. Similar to the failure-to-pay penalty, the Taxpayer will have to pay 0.5% of the quarterly estimate due, for each month, or part of a month, that the tax remains unpaid from the estimate due date. This penalty may even be charged when the Taxpayer is due a refund when filing their annual tax return because the required estimates were not paid in a timely manner.
  • EXAMPLE – Taxpayer C owes quarterly estimate payments of $5,000 each quarter to the IRS for the 20XX tax year. For the first three quarters, the Taxpayer made timely estimate payments. However, for the fourth quarter, the Taxpayer made a $5,000 payment on March 1st, which is 1.5 months after the fourth quarter estimate due date of January 15th. The Taxpayer will owe a late estimated tax payment penalty of $37.50 (($5,000 x 0.5% = $25) ($25 x 1.5 mo. = $37.50).
• Important Note – The IRS has a “Safe Harbor” rule which protects Taxpayers from an underpayment penalty when certain conditions are met. If the Taxpayer meets either of the following, then no underpayment penalty will be applied:
  • The Taxpayer paid at least 90% of the tax owed for the current year, or 100% of the tax owed for the previous year.
    • For high-income Taxpayers (Adjusted Gross Income over $75k ($150k if Married Filing Joint)), the Taxpayer must pay at least 90% of the tax owed for the current year, or 110% of the tax owed for the previous year.
  • The Taxpayer owes less than $1,000 in tax after subtracting withholdings and credits.

At a time when tax law changes, automated notices, and a backlog of paper filed returns are creating more difficulty communicating with the taxing authorities, it’s important to have a good understanding of the above and how it may impact you. So, how do you avoid these tax penalties? Be sure to file timely tax returns or extensions and to make all tax payments by the applicable due dates.

As always, contact your Bronswick Benjamin, PC trusted advisor if you have any questions or concerns. We are here to help!

Bronswick Benjamin, PC

Article by David Thompson, June 8, 2022