IRS Tax Problems

A Guide to Interest and Penalties on Your Tax Return

8/9/2017

When it comes to filing your taxes, you are already contending with several confusing, and what may seem like contradictory, rules. Calculating interest and penalties are no exception as there are different circumstances for being penalized, and you may be unsure what is the correct balance to use or the compounding period. In order to understand these calculations, you need to become familiar with why the IRS charges penalties and when they would kick in.

Underpayment Penalties

Underpayment penalties are the most common type of IRS penalty that people are likely to encounter. There are two distinct types of underpayment penalties that are frequently confused as being one in the same, but are not: failure to file and failure to pay. These are related to filing your taxes late and owing taxes.

Failure to File

A failure to file penalty arises when you don't file a tax return at all, or file it late. This penalty is based on your balance due (if you have one) by assessing you 5% of the balance due for every month that your tax return is late. Partial months, even just a few days, count as a full month of your return being late, so you definitely want to file your return within the filing deadline as closely as possible.

You are assessed a maximum of 25% for a failure to file penalty, or five months. Once you are 60 days past the tax filing deadline, including extensions, then your minimum late filing penalty is the smaller of $135 or 100% of your balance due so you would have to pay this even if you were due a refund.

You should file an extension (if you are not automatically granted one, such as being an eligible member of the armed forces) if you don't think you'll be able to get your tax return filed by the deadline. Even if you do owe taxes and expect to be unable to afford to pay your tax bill right away, you should still file the return to prevent this penalty.

Failure to Pay

Failure to pay penalties simply result from having unpaid taxes and will be 0.5% of the unpaid balance per month. If you pay off some of your balance but still owe taxes at the end of the month, the new smaller balance will be the basis for 0.5% and not the original balance.

There are also circumstances in which the IRS will waive the failure to pay penalty such as if you are experiencing hardship like medical bills, domestic violence, or eviction.

Calculating IRS Interest

The IRS interest rate changes every quarter (three months), and you can find the underpayment interest rate published on their website. It is based on the federal short-term interest rate plus 3%, and it is compounded daily. For the third quarter of 2017, the underpayment interest rate is 4%.

To calculate the interest, you need to examine your balance due and how long your taxes have gone unpaid. For back taxes with numerous years involved, this calculation can get onerous, since the underpayment period begins at the due date for each tax return in question until the date of payment. Interest does not start being charged on the date you realize you owe taxes or when the IRS sends you a bill. It starts on the due date.

For example, you missed the tax filing deadline and got your return in late. You owe $1,000 in federal taxes on this return. Using the current rate of 4%, your interest calculation for that one day is $40. Then the next day, your balance would compound to $1,081.60 ($41.60 in interest.) The interest will continue to compound until your balance has been paid in full. Since it compounds daily, interest adds up much faster than underpayment penalties.

Interest also can't be waived, so the consequences of accumulating back taxes are much harsher. Even if you file for an extension or make arrangements for a payment plan, the interest continues to rack up in a manner similar to credit cards (the daily compounding at work), until the balance has been paid off.

Accuracy-Related Penalties

If any amounts on your tax return have been adjusted by the IRS and a tax increase results, you may be assessed an accuracy-related penalty. This penalty applies to underreporting income and is 20% or 40% of the total tax increase.

This can happen because of valuation misstatements (such as overstating the value of charitable donations) or disregard of tax laws. Accuracy-related penalties may be waived in certain cases, such as errors or problems with a form issuer (if the 1099 doesn't match with your records, for instance.) Willful disregard of the law results in the steeper 40% penalty.

Tax Fraud and Protest

Filing a "frivolous" tax return (such as purposely trolling the IRS by entering 0's or obviously false numbers in every row) or intentionally filing a misleading tax return results in a criminal penalty from the IRS that can result in jail time. "Tax protesters" who claim that the tax code is not part of the Constitution, and therefore, US citizens don't have to file and pay taxes are also subject to penalties and potential jail time.

Tax fraud penalties are sizable, well into six or seven figures depending on the severity of the fraud and how much money is in question, that result in judgments even after Tax Court has seized your assets.

Judicial Relief of Civil Penalties

Underpayment and accuracy-related penalties are civil penalties that will not result in asset seizure, unless you ignore your tax bills so long that the IRS has begun the lien process. You will not go to jail for being faced with these penalties.

While a judge will virtually never abscond underpayment penalties, all other civil penalties related to accuracy (and those pertaining to ownership of foreign corporations and employment taxes, which are beyond the scope of this guide) may be waived if the judge deems your situation fit.

However, if you are found to have recklessly and willfully violated tax laws by committing or abetting tax fraud or protest by filing frivolous returns or petitions, you can face asset forfeiture and jail.

Karen Drescher, CPA writes for TaxBuzz, a tax news and advice website. Reach her at [email protected].

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Karen C. Drescher, CPA, CGMA

Whether it is helping a individual or a Georgia small business with their taxes, or offering to be a backstop through their difficulties, Karen is always there for her clients. When you are a client of Karen's, she always tries to make you feel comfortable in a casual and friendly environment.

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Liability Limitation and Usage Guidelines for TaxBuzz AI:
Limitation of Liability:

TaxBuzz AI is a tool designed to provide tax professionals with assistance in generating responses to tax research questions. While we strive to maintain the accuracy and reliability of the information provided, it is imperative to recognize that tax laws are dynamic and subject to change. Therefore, the use of TaxBuzz AI should be complemented by professional judgment and consultation with legal and tax experts.

By utilizing TaxBuzz AI, you acknowledge and agree that the information generated should not be considered as a substitute for professional advice tailored to your specific circumstances. We explicitly disclaim any liability for the consequences arising from the use of advice generated by TaxBuzz AI. Users are encouraged to independently verify the information and seek professional advice before making decisions based on the AI-generated responses.

Usage Guidelines:
- Professional Judgment: TaxBuzz AI is a tool to aid tax professionals in research and analysis. It is not a replacement for professional judgment, and users should exercise their expertise when interpreting and applying the information generated.
- Consultation with Experts: While TaxBuzz AI provides valuable insights, it is crucial to consult with legal and tax experts to ensure the advice aligns with the latest legal developments and specific nuances of a particular situation.
- Verification of Information: Users are responsible for independently verifying the information provided by TaxBuzz AI, especially in instances where the advice generated is critical to decision-making.
- Educational Purposes: TaxBuzz AI is intended for educational and informational purposes only. It is not intended to provide specific legal or tax advice tailored to individual circumstances.
- Non-Endorsement: The use of TaxBuzz AI does not constitute an endorsement or guarantee of the accuracy of the information provided. Users are encouraged to corroborate the advice with other reliable sources.
By accessing and using TaxBuzz AI, you agree to abide by these terms and acknowledge the limitations outlined herein. We reserve the right to modify these terms at any time, and your continued use of TaxBuzz AI constitutes acceptance of any such modifications. If you do not agree with these terms, please refrain from using TaxBuzz AI.

TaxBuzz.com is a service of CountingWorks, Inc., 2549 Eastbuff Drive., #448 208, Newport Beach, CA 92660

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