IRS penalties can add up quickly if you file late or pay late. God forbid you make the IRS agent angry and get hit with a fraud penalty. IRS penalties can range from .5% to 75% of the amount of tax due, so be careful when dealing with the collection machine. Knowing your rights is the only way to negotiate or eliminate improperly assessed IRS penalties.
The most common IRS penalties are for filing and paying late. Of these, the IRS penalty for filing late is a killer. The penalty for filing late is 4.5% per month. That’s 4.5% for a full month or any part of a month. So, filing 36 days late will result in a 9% penalty.
The IRS penalty for paying late is .5% for any month or part of a month. It is important to note that the late payment penalty begins on April 16, the date after your return is due. The automatic extension from April 15 to October 15 on a personal income tax return extends the time to file but not the time to pay.
It’s common for people to ignore the payment deadline and pay and IRS penalty of 2.5% in October. You can eliminate this IRS penalty by making an estimated payment with your extension on April 15, and then filing your tax return on October 15. If you owe money on October 15, the late payment penalty will only apply to the balance due.
Those of you who did the math on my calculation of 2.5% above might have noticed that this is not .5% per month from April to October, or 7 months. The IRS penalty for both late filing and late payment is capped at 5 months. If you pay later than 5 months, only interest might be added to the balance due… though, read on.
Therefore, the maximum IRS penalty for filing and paying late is 25%, which is 4.5% for filing late for 5 months and .5% for 5 months of paying late. Considering the difference between the IRS penalty for filing late and the IRS penalty for paying late, it is in your best interest to file you tax return on time even if you can’t afford to make a full or partial payment.
Forgetting the IRS penalties for a minute, if you can’t afford to pay, it is usually in your interest to file as soon as possible and get the 10 year IRS collection statute moving. Please see my article on the IRS collection statute.
If the IRS is forced to chase you down for the balance due, usually because you have not been proactive or are unable to pay them off in 12 to 24 months, there is a 1% penalty (you could call it a user fee) for having to issue a notice of levy. The IRS penalty for a notice of levy is 1% per month up to 25%, thus it can run for 25 months or until the debt is paid in full.
If you file a frivolous tax return, or otherwise infuriate the IRS agent, you can be hit with a fraud penalty. The IRS penalty for fraud is 15% per month up to 75%. In the business, we refer to the IRS penalty for fraud as the 75% penalty because no one ever perpetrates a fraud for only one month. In 12 years, I have never seen or heard of an IRS penalty for fraud that was less than 75%.
The fastest way to earn the IRS penalty for fraud is to file a return with all zeros or that is otherwise false. Also, you might see the fraud penalty when someone understates their income on a return by 25% to 50%, with someone who is protesting taxes as being unconstitutional, or someone who takes a position that the Service deems to be frivolous.
IRS penalties can be abated or reduced for good (i.e. very good) cause. For more information on this topic, please see penalty abatements on this site.
I will conclude by noting that interest also applies to late payments. Interest charged by the IRS may not be abated for any reason. No matter how good your story is, you will be stuck with IRS interest.
Interest is calculated using a variable rate and has been 4% to 8% in recent history. I usually tell clients they can guesstimate IRS interest at 5.5% and be safe.
Because of the relatively low interest rate charged by the IRS, people might be inclined to file late and pay late so they can use the cash in their business or investments. If you are getting 15% on your money you don’t mind paying 5.5% to the IRS. That’s why the IRS penalties are there. They should make it expensive to delay payment… especially too expensive to delay both filing and payment.