Understanding IRS Tax Payments – penalties, fees and interest charges
April 15th is famously – or infamously – known as “Tax Day” to most U.S. citizens and is the deadline for most individuals to file their U.S. income tax returns and pay any tax due. If one is outside the United States on 15-April , there is an automatic 2-month extension to file the tax return and pay any federal income tax that is due. Note, one will still have to pay interest on any tax not paid by 15-April.
If one is inside the United States on 15-April, there is an option to request an extension of time to file the tax return and receive a 6-month extension to file the tax return and avoid the penalty for filing late. Those outside the U.S. on 15-April who qualify for the automatic 2-month extension have the option to request an additional 4-month extension to give them until 15-October to file. Unlike the 2-month extension for living outside the United States, this is NOT an extension of time to pay taxes and you will be subject to the failure to pay penalty AND interest (however you will avoid the failure to file penalty).
In addition to the interest on any tax not paid by 15-April, there is also a possibility of an estimated tax penalty that can be assessed with a timely tax filing. This is known as a Penalty for Underpayment of Estimated Tax.
We will try to outline below the different types of penalties, fees and interest – and how everything is calculated.
Interest: If you have any tax due on 15-April when the tax return is originally due – even if you are granted an automatic extension – you will need to pay interest on that amount starting from 15-April. Interest accrues on any unpaid tax from the due date of the return until the date of payment. The interest rate is determined quarterly and is the federal short-term rate plus 3% and compounds daily.
Failure to Pay Penalty: If you file a return but do not pay the full amount of tax due on time, you will have to pay a late payment penalty. As mentioned above, this due date is 15-April even if you request a 6-month extension. However, if you qualify for the automatic 2-month extension then the failure to pay penalty is not assessed until 15-June.
The penalty is calculated as one-half of one percent for each month, up to a maximum of 25% on the amount of tax that remains as unpaid from the due date of the return until it is paid in full. The rate increases to one percent if the tax remains unpaid ten days after the IRS issues certain notices.
Failure to File Penalty: If you do not file a return on time and have not been granted a proper extension, you will have to pay a failure to file penalty. The penalty is calculated as five percent of the tax owed for each month, up to five months. If the return is over 60 days late, there is a MINIMUM PENALTY for late filing which is the lesser of $135 or 100% of the tax owed unless you had “reasonable cause and acted in good faith”.
Penalty for Underpayment of Estimated Tax: If you have tax due for the year, regardless of when you make payment, you could also have an additional penalty for the underpayment of estimated tax. The idea is that the United States income tax is a “pay-as-you-go” tax, which means you are required to pay tax as you receive income throughout the year. If an insufficient amount of tax is withheld, you are required to make estimated tax payments. If you did not pay enough tax throughout the year by withholding or/and making estimated payments, you may have to pay a penalty for underpayment of estimated tax. Most taxpayers can avoid this penalty if (1) they owe less than $1,000 in tax after subtracting their withholding and estimated tax payments, or (2) they paid at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year. Generally, to avoid a penalty taxpayers should make estimated tax payments in four equal amounts, however you may be able to vary the amounts of the payment to avoid or lower the penalty in certain ways.
In some situations, the IRS may abate penalties for filing and paying late if one has reasonable cause and the failure was not due to willful neglect. In such cases, interest charges are not abated. Making a late payment as soon as possible may help establish that the initial failure to pay timely was due to reasonable cause and not willful neglect. That being said, the safest way to avoid penalties and interest is to make tax payments consistent with earning income and in cases of uncertainty always make advanced payments.