IRS Penalties and What You Should Do About Them

There’s nothing fun about having to deal with tax penalties and interest due on late penalties, but they should never be ignored. The biggest mistake people make when they find themselves in a penalty situation is they ignore it. This only makes the problem worse. The interest compounds and the penalties grow as well.

Under federal tax law the IRS can levy both interest for payments that are late as well penalties to encourage filers not to repeat the mistake again. These are civil remedies that are commonly applied in most late payment situations. That said, the IRS can also pursue criminal penalties where it decides that intentional tax evasion or fraud has occurred.

The most frequent problem filers incur is missing a tax filing deadline. It doesn’t matter that the IRS offers filing extensions, if you missed the deadline without first asking for the extension then you missed it, period. This triggers two problems. The first is a failure to file altogether which will trigger a filing penalty. Second, interest begins to accrue from the date a filing was due if a payment ends up being owed.

If, on the other hand, you did file on time, but the information was incorrect and you actually owe more, than you will deal with interest for the difference of what was owed plus a penalty for late payment. Fortunately, however, you are treated as filing on time. Clearly, if you have to choose between filing or missing a deadline, filing on time is the far better choice in the penalty world.

Calculating how much you will owe depends on how long out you were from deadlines and when the correct payment was due. You have a choice then to either file and let the IRS calculate the figures for you, or file and pay an estimated combination of payment, interest, and penalties. The IRS will take this into account, calculate what you really owe and either bill you for the different still due or refund the difference overpaid.

The last thing a person should do is ignore or delay paying charges from the IRS. Even if you don’t agree with the bill, pay it first then dispute it later. If you are in fact deemed correct, a refund can be arranged after the fact. But interest and penalties will continue to accrue if a balance due is not paid. The IRS will then give a certain amount of time stated in a notice to you by when to pay. After a number of contacts, then the agency will seek a lien against any bank accounts, payroll, payment due to you, and assets to satisfy the balance due. This can include forced withholding on any payments or distributions meant for you from restricted funds such as retirement accounts.

If you try to estimate your interest and penalty payment to pay it off as quick as possible, the measurements are predictable. A late filing penalty will cost 5 percent of the outstanding tax amount due, compounding monthly for every month the payment is late. The penalty is capped at a total of 25 percent of the amount due. However, this figure jumps after 60 days to at least $135 or 100 percent of the tax due.

For those with outstanding taxes still due, or underpaying taxes and owing more, then you will need to figure on a half of 1 percent interest for every month the amount is outstanding. This accumulation continues until it gets to 25 percent of the balance due.

On the other hand, if you put in an extension for filing your taxes and paid up to 90 percent of your taxes due, you will get a break from the IRS. The difference can be paid without calculation of interest as long as it is paid by the extension deadline date. But the 90 percent has to be paid by the original deadline (for example, April 15 for personal income taxes due).

There is a clause in the tax code that lets a filer off the hook if nonpayment or non-filing was due to “reasonable cause” versus intentional or negligent failure. However, what actually counts as reasonable cause as a definition is up to the IRS, which decides the application on a case-by-case basis.

If you find yourself in a payment situation, and you’re short on cash to pay the bill, you need to be realistic about the issue. If you have a credit card, pay the difference on the card and carry the interest there until you can pay off the issue. A credit card debt will be far easier and less costly to deal with than a tax debt due to the government. If your credit card is not enough or you don’t have one, see if a relative or friend can help you. Alternatively, you can try to get a consumer loan from a bank. The worst they can do is say “no.” If these options don’t work, consider selling some of your more valuable assets in hand via online auctions, classified ads, or a garage sale. You’ll be amazed how much you can raise when you really need the funds. Even if you raise only a part of the bill, pay it. This will reduce what can be used to develop interest or penalties against you.

Finally, if other sources don’t work, consider getting a second job at least until you get enough funds to pay off the tax bill. Again, don’t let the tax bill fester. Once the IRS collection process begins, everything you have becomes a target for seizure and tax liens, including your paycheck and personal property.


U.S. Internal Revenue Service: Avoiding Penalties and the Tax Gap

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