If you owe money to the IRS on your income taxes, penalties and interest start to accrue immediately after April 15. Even if you file an extension, penalties apply from April 15 and not the date you file your extension. And there’s nothing you can do to stop your tax debt from stacking up until you pay off your bill in full. But the good news is that there are steps you can take to minimize IRS penalties and interest. You may also qualify for penalty abatement, which could reduce the amount the IRS expects you to pay back.
This guide explains some of the basic penalties that individual taxpayers can face from the IRS, as well as how interest accrues on tax debt. We also explain how you may be able to qualify for penalty abatement. If you owe back taxes, don’t wait! Connect with a certified tax professional as soon as possible to find solutions that may reduce tax penalties and interest.
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How does the IRS charge penalties and interest?
If you owe money on your annual income tax return, penalties apply immediately on the day taxes are due. So, in most cases, penalties begin to apply immediately on April 15th and interest starts to accrue accordingly. In general, the only way to avoid your tax bill from growing quickly after April 15 is to pay off any amount you owe in-full on that day.
As mentioned above, filing a tax extension won’t put off penalties. Once you file your taxes, penalties on any balance owed would be retroactively applied, starting from the date income tax returns were due that year, says Josh Zimmelman of Westwood Tax & Consulting.
The late filing penalty is 5% of the tax owed. It’s assessed the very first day you’re late and every month after that, and it can get up to 25% of your tax bill. If you owe $10,000, that’s a $2,500 penalty. If you request an extension, you get an extra six months to file, and as long as you file within that window, you don’t have to worry about this penalty.EXPERT: Josh Zimmelman, Managing Director of Westwood Tax & Consulting
Common IRS penalties
The two most common IRS penalties are a failure-to-file penalty and failure-to-pay penalty.
|Penalty||Amount and rules|
|Failure-to-pay||One-half of one percent for each month or part of a month that your tax bill remains unpaid, up to a maximum of 25%.|
|Failure-to-file||Five percent of the tax owed for each month or part of a month your return is late, up to a maximum of 25%|
For failure-to-pay penalties, there’s a way that you can increase the penalty percentage and a way to decrease it.
- You can decrease the penalty to one-quarter of one percent if you filed your tax return on time and set up an installment agreement. The decrease remains in effect as long as you’re enrolled and making payments on time.
- On the other hand, you can increase the penalty to one percent if your tax remains unpaid 10 days after you receive a notice of intent to levy property from the IRS. In other words, if you try to hide from the IRS and ignore their communications, your penalties increase.
The IRS caps all penalties at 25%, so the penalties that apply to your unpaid tax balance will never exceed that. However, penalties can quickly stack up to that 25% threshold, especially if you go several months without filing. When it comes to the IRS, putting things off is never in your best interest.
Don’t wait to get the help you need. Find out exactly how much you owe the IRS with a free analysis from a certified tax professional.
Other IRS penalties
While failure-to-file and failure-to-pay are the most common IRS penalties, they’re not the only ones that individual taxpayers may encounter. Another common penalty is failure to pay estimated tax penalty.
If you are self-employed, take freelance work, or work a side gig and earn enough to owe $1,000 in income tax annually, the IRS expects you to pay estimated taxes quarterly. You basically have to estimate how much you will owe the IRS by April 15 and then break that amount up into quarterly payments that you make throughout the year.
If you don’t make these estimated tax payments up to a certain percentage of what you owe for the year, then the IRS penalizes you. The penalty is interest-based and applies to the amount the IRS deems you should have paid in a timely manner.
There are also penalties that may be applied for inaccurate information on your tax return. There’s an accuracy-related penalty and then a bigger civil fraud penalty. These types of penalties occur if you don’t report your earnings accurately on your tax return or knowingly attempt to falsify your tax return to make it seem like you owe less.
How does the IRS apply interest?
Interest charges are often the reason that a taxpayer’s tab to the IRS grows so quickly. The interest rate on tax debt is calculated by taking the current federal funds rate and adding three percent. Currently the federal funds rate is at 2%, so the interest rate on tax debt would be 5%.
The real issue with interest on tax debt is how quickly it compounds. Compound interest means that interest charges from one month get rolled into the total debt owed for the next interest rate calculation. The faster interest compounds, the faster a debt grows. Interest on tax debt compounds daily. That means the IRS essentially applies new interest charges every single day until you finally pay off your balance.
The IRS recalculates the interest rate applied to a taxpayer’s balance every quarter (every three months). The new rate only applies to your balance moving forward, it does not change the rate applied to your balance previously.
Interest charges start on April 15 if you don’t pay any balance you owe in-full on that date. It also applies to any penalties you incur:
- Interest on failure-to-file and accuracy-related penalties start on the tax return due date, usually April 15. Filing a tax extension doesn’t avoid this.
- Interest on failure-to-pay and estimated tax penalties start on the date the IRS sends you a notice of the amount due.
Penalty relief: How to get IRS penalties waived
If you’re reeling from how quickly penalties and interest are increasing the amount you owe, there is some good news. The IRS offers several types of penalty relief, meaning they will reduce or waive penalties that were applied to your balance. Interest applied to those penalties would automatically be reduced as well.
IRS penalty relief may apply to all the penalties we describe above, as well as other penalties, as applicable. There are three basic ways that the IRS offers penalty relief:
First-time penalty abatement
If you’ve been a responsible taxpayer that generally pays on time, the IRS offers penalty abatement on failure-to-file, failure-to-pay and failure to pay estimated taxes. You can qualify for penalty abatement if:
- You haven’t received any tax penalties in the three years prior to the year you received a penalty.
- You’ve filed all your tax returns on time or at least filed extensions on time.
- You have at least made arrangements to pay any tax you owe.
Penalty abatement only applies to the penalties and interest incurred up to the point you apply for penalty abatement. If you’re currently facing failure-to-pay penalty, the penalty amount and associated interest will continue to accrue until you pay your tax bill in full. So, you should wait until you finish your installment agreement or pay off the rest of your tax debt before you apply for penalty relief.
Get the help you need to reduce IRS penalties and interest and find solutions to get out of tax debt without overpaying.
Relief for reasonable cause
If there was a good reason that you couldn’t meet your tax obligations on time, then the IRS will give you penalty relief in this case as well. This generally involves encountering challenges that are entirely out of your control. For example, if your tax return is filed late because you were in the midst of a natural disaster, the IRS will waive the failure-to-file penalty and any associated interest.
Common reasons that qualify for reasonable cause include:
- Natural disasters or fire
- An accident that incapacitated you
- Death or serious illness of the taxpayer or a member of the taxpayer’s immediate family
Reasonable cause can also apply to the failure-to-pay penalty. Although a general lack of money available to pay what you owe won’t qualify you for penalty relief, lacking funds because you used the money for a reasonable cause would. So, in the example above, if you didn’t pay your taxes on time because the money was used to recover from a natural disaster, that would qualify for relief.
In order to qualify for this type of relief, you must submit documentation that establishes reasonable cause.
Relief for a statutory exception
The final way to receive IRS penalty relief is by qualifying for a statutory exception. “If you received incorrect written advice from the IRS, you may qualify for a statutory exception.”
Basically, the IRS will grant penalty abatement if you can show that following the written advice you received from an agent of the IRS led to the penalty.
Steps to reduce IRS penalties and interest
Most people don’t start out owing hundreds of thousands of dollars to the IRS. However, even if you owe just a few thousand, the amount can grow quickly once penalties and interest apply. Before you just pay the amount that the IRS says you owe, it’s a good idea to see if you can qualify for any type of penalty abatement or relief.
First, you need to know exactly how much you owe and how much of that amount is penalties and interest.
- Go to FreeIRSreport.com.
- Complete a form to authorize a licensed tax practitioner to receive information about your tax debt.
- You’ll also complete a 60-second survey to provide information that will help the practitioner as they analyze what you owe.
- In 7-10 business days, you’ll receive an IRS Tax Report that breaks down what you owe, including how much you owe in penalties and interest.
- The report will also include recommendations from the practitioner and flag any areas of concern that you need to pay special attention to.
Once you receive the analysis, you’ll be better informed to be able to solve your issues with the IRS. In some cases, you may be able to use the analysis to solve your issues with the IRS directly. If your situation is more complex, you may require professional help. The analysis will set you up to have an informed conversation with a tax attorney to ensure they understand your situation. They can then help you take the right steps to pay your tax bill and apply for penalty abatement at the right time.
Article last modified on May 24, 2023. Published by Debt.com, LLC