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How Does the IRS Calculate Penalties and Interest?

The deadline for taxpayers who filed an extension this year is Monday, October 17th. Keep in mind that filing an extension does not extend the date on which your taxes are due, it simply extends the date when your return must be filed.


If you wait until October to file your return, but fail to make the estimated tax payment that was due back in April, you will receive a notice from the IRS requesting additional interest and penalties. These notices can be confusing, as they provide little clarification as to the reason for the increase in your tax bill.


This week’s release will concisely summarize the five types of penalties and interest charged by the IRS when taxpayers move outside the boundary lines.


Types of IRS Penalty Charges

Late Filing Penalties

If you owe tax and don’t file a return or extension on time, IRS regulations state that an additional penalty of 5% of the tax due will be charged to the taxpayer for each month your return is late (maximum of 25%). This penalty is in addition to BOTH the tax owed and the interest on the past due tax.


Failure to Pay Penalty

If you fail to pay your taxes, the IRS will penalize you based on how long your overdue taxes remain unpaid. Even if you file an extension and file your return before October 17th, this penalty will still apply, as your tax payment was due by April 15th.


The penalty will be a percentage of the taxes you didn’t pay or a percentage of the taxes you didn’t report on your return. Each month your taxes remain unpaid generates a 0.5% penalty, so paying your tax bill 2 months late would result in a 1% penalty. The failure to pay penalty has a maximum charge of 25% of your unpaid taxes.


Underpayment of Estimated Tax

The underpayment of estimated tax penalty can apply to individuals, even if they receive a refund. The penalty is issued when the individual fails to pay the estimated amount of tax on their income or fails to pay the estimated tax by the due date.


For most taxpayers that withhold income through their W2, this underpayment of estimated tax penalty does not factor in. However, for self-employed individuals or people with large income swings such as a rental property sale, this can often cause an unpleasant surprise.


Accuracy-Related Penalties

Accuracy-related penalties are charged when taxpayers claim deductions they shouldn’t, or they fail to report all their income. There are two common examples of this:

  • Negligence or Disregard of the Rules or Regulations Penalty: An individual can receive this penalty if they don’t make a reasonable attempt to follow tax return laws or if they intentionally ignore the tax laws when filing their return.

  • Substantial Understatement of Income Tax: An individual receives this penalty when the tax shown on their return is understated by 10% or $5,000 depending on which amount is larger.

Accuracy-Related Penalties are subject to a 20% of understated tax penalty.


Dishonored Checks

If a check bounces or a bank account lacks sufficient funds to make a tax payment, the taxpayer will be subject to a Dishonored Checks Penalty. If this occurs, the Dishonored Check Penalty is $25 if the payment amount is less than $1,250, or 2% of the payment amount if it is more than $1,250.


Interest Charges

In addition to penalties, the IRS charges interest on late or unpaid taxes. The interest charges begin with the original due date of the return (generally April 15th) and end when the IRS receives payment of the tax due. Tax payers will incur interest charges even if they have a payment plan in place. If there is a tax that is due beyond the due date, the taxpayer will incur interest charges.


The interest rate on unpaid Federal tax is determined and posted every three months. It is the federal short–term interest rate plus 3 percent. Interest is compounded daily. Below are the interest rates since January 2019.

Time Period

Interest Rate

1/1/19-6/30/19

6%

7/1/19-6/30/20

5%

7/1/20-3/31/22

3%

4/1/22-6/30/22

4%

7/1/22-9/31/22

5%

10/1/22-12/31/22

6%

Abatement of IRS Penalties and Interest

As a rule of thumb, you may request an abatement of penalty if you show cause. While you can request an abatement of penalties, interest on late tax payments are not as likely to be removed.


If you have not filed your 2021 tax return and you need help getting that done by the 10/17 deadline, reach out to Monotelo and we will help you get your affairs in order.




This article is a general communication being provided for informational and educational purposes only and is not meant to be taken as tax advice, investment advice or a recommendation for any specific investment product or strategy. The information contained herein does not take your financial situation, investment objective or risk tolerance into consideration. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. Any examples are hypothetical and for illustration purposes only. All investments involve risk and can lose value, the market value and income from investments may fluctuate in amounts greater than the market. All information discussed herein is current only as of the date of publication and is subject to change at any time without notice. Forecasts may not be realized due to a multitude of factors, including but not limited to, changes in economic conditions, corporate profitability, geopolitical conditions, inflation or US tax policy. This material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.




LEGAL, INVESTMENT AND TAX NOTICE. This information is not intended to be and should not be treated as legal, investment, accounting or tax advice.




PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

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