You Mean I Can Owe More Than Just Taxes?

Civil Penalties and Interest Explained

Have you ever forgotten to file your tax return on time? What about missing the payment deadline if you owed taxes? Did you wonder why the “taxes owed” amount was not the entire amount you had to pay the IRS? This article, along with subsequent articles, will explain why.

Congress has enacted a number of civil and criminal penalties in the Internal Revenue Code, which are designed to deter noncompliance. Though the spirit of the civil penalties is to ensure taxpayers comply with tax, the IRS is also raising revenue. Although the IRS has established over 140 civil penalties, the most common include:

Along with civil penalties, the IRS is statutorily required to charge interest on underpayments, nonpayments, or extensions of time for payment of tax. According to Internal Revenue Code (“IRC”) § 6601(a), if any amount of tax imposed is not paid on or before the last date prescribed for payment, interest on such amount will be charged until the taxes are paid. For individual income taxpayers, the last date prescribed for payment is the original tax filing deadline (usually April 15th). Similarly, under IRC § 6601(e)(2), interest shall also be imposed on penalties, additional amounts, or additions to the tax if such penalties, additional amounts, or additions are not paid within 21 calendar days from the date of an IRS notice and demand. In such case, interest will be imposed for the period from the date of the notice and demand to the date of payment. Such interest rates are published monthly by the IRS in accordance with IRC § 1274(d) and the total interest is compounded daily.

Failure to File

According to IRC § 6651(a)(1), when a taxpayer does not file their tax return by the return due date (usually April 15th) or the extended due date (usually October 15th if an extension was requested and approved), the taxpayer will face a 5% per month penalty of the unpaid tax required to be reported. The failure to file penalty maxes out after five months or 25% of the unpaid tax required to be reported. Below is a breakdown of the penalty base, maximum and minimum, and when interest starts.

Penalty base: The penalty is computed on the tax required to be shown on the return, reduced by payments and credits on or before the payment due date.

Maximum: The maximum amount of the penalty is 25%. The penalty is reduced by the IRC § 6651(a)(2) penalty for failure to pay tax shown for periods when both penalties apply. If the failure to file is considered fraudulent, the penalty rate is 15% per month instead of 5% per month, and the maximum penalty is 75% instead of 25%.

Minimum: For income tax returns that are more than 60 days late, the failure to file penalty is subject to a minimum amount of $135 or the underpayment of tax, whichever is less. This minimum is not applicable to employment or excise tax returns.

When interest on the penalty starts: Interest on this penalty begins on the due date of the return, including any extensions, and ends on the date the penalty is paid. IRC § 6601(e)(2)(B).

Failure to Pay Tax Reported on Return

According to IRC § 6651(a)(2), the IRS may impose a penalty of 0.5% per month (to a maximum of 25%) for late payment. The penalty increases to 1% per month if the taxpayer does not pay within 10 days of a notice of intent to levy. The amount of unpaid tax subject to the penalty is reduced by the amount of any tax which is paid on or before the beginning of a month. The failure to pay penalty acts to reduce the IRC § 6651(a)(1) failure to file penalty for periods when both penalties apply. Thus, the late filing penalty would max out at 22.5% and the failure to pay penalty would max out at 25% for a combined total penalty of 47.5%.

Interest on the penalty runs if the taxpayer receives a notice and does not pay. If a penalty is not paid, the amount of the penalty due on the notice date will begin to accrue interest.

If the taxpayer has an installment agreement in effect, IRC § 6651(h) requires the 0.5% penalty to be reduced to 0.25%. The reduction is allowed only if the taxpayer filed a timely return.

The failure to pay penalty does not begin to run if the taxpayer has an extension of time to pay. However, unlike extensions of time to file, extensions of time to pay are extremely rare.

Penalty base: For any month, the penalty is computed on the amount of tax shown on the return reduced by payments on or before the beginning of such month and by any allowable credits. If the return is due and filed on April 15, 2019, showing tax of $1,000 with no payments and $400 is paid July 1, 2019, the penalty base will be $1,000 for the first three months and $600 until the next payment.

Maximum: The maximum amount of the penalty is 25%. The rate increases to 1.0% per month after notice of intent to levy under IRC § 6331.

Maximum: None

When interest on the penalty starts: Interest is charged from the date of notice and demand to the date of payment of the penalty. However, under IRC § 6601(e), the interest shall be imposed to the penalty only if the penalty is not paid within 21 calendar days of the notice and demand (10 business days if the amount on the notice and demand is equal to or exceeds $100,000). According to Treas. Reg. § 301.6651-1, the first penalty month begins at the expiration of the grace period.

Failure to Pay Tax Not Reported

According to IRC § 6651(a)(3), the failure to pay unreported tax penalty applies to amounts assessed by the IRS, and then not paid. This penalty differs from the IRC § 6651(a)(2) failure to pay penalty above which applies to amounts shown on a return. The failure to pay unreported tax penalty, otherwise known as the failure to pay assessed tax penalty, begins when the taxpayer receives an IRS notice and demand to pay, but fails to pay within a 10- or 21-day grace period.

The failure to pay assessment penalty imposes a penalty of 0.5% per month (to a maximum of 25%) for the failure to pay amounts assessed. The penalty increases to 1% per month if the taxpayer does not pay within 10 days of a notice of intent to levy. The amount of unpaid tax subject to the penalty is reduced by the amount of any tax which is paid on or before the beginning of a month.

Like the failure to pay penalty above, if you have an installment agreement in effect, the 0.5% penalty is reduced to 0.25% under IRC § 6651(h). The reduction is allowed only if you filed a timely return.

Interest on the penalty runs if the taxpayer receives a notice and does not pay. If a penalty is not paid, the amount of the penalty due on the notice date will begin to accrue interest.

Penalty base: If the return is due and filed on April 15, 2019, showing tax of $1,000 with no payments and $400 is paid July 1, 2019, the penalty base will be $1,000 for the first three months (starting May 6th, since the penalty is imposed based on failure to pay within 21 days of the date of notice and demand), and $600 until the next payment.

Maximum: The maximum amount of the penalty is 25%.

Minimum: None.

When interest on the penalty starts: Interest is charged from the date of notice and demand to the date of payment of the penalty. However, under IRC § 6601(e), the interest shall be imposed to the penalty only if the penalty is not paid within 21 calendar days of the notice and demand (10 business days if the amount on the notice and demand is equal to or exceeds $100,000). According to Treas. Reg. § 301.6651-1, the first penalty month begins at the expiration of the grace period.

Failure to Pay Proper Estimated Tax

According to IRC § 6654 (IRC § 6655 for corporations), the IRS may impose a penalty if income tax withheld plus estimated tax payments is less than the required installments. Estimated tax payments are generally required for taxpayers who are expected to owe at least $1,000 when their tax return is filed. The penalty is computed in the same way as described above for interest on an underpayment. For example, the amount of interest charged from the installment due dates to the due date of the return is equal to the amount of the estimated tax penalty. However, interest on the penalty does not run until the IRS sends notice and demand to pay the penalty.

Under IRC § 6654(c), there are four required installments for each taxable year. If a taxpayer must make estimated tax payments, the due dates are as follows:

To ensure that the tax is paid, IRC § 6654(d) provides that the amount of each of the four required installments be 25% of the “required annual payment.” The required annual payment means the lesser of 90% of the tax shown on the return for the taxable year or 100% of the tax shown on the return of the individual for the preceding taxable year. What this means is if the taxpayer owed $1,000 or more for the prior tax year, they will be required to make estimated tax payments of an equivalent amount for the current tax year. Below is an example.

For tax year 2017, Taxpayer owed $24,000 to the IRS. Taxpayer has not begun preparing their 2018 tax return. Therefore, under IRC§ 6654(d)(1)(B), Taxpayer’s required annual payment would be 100% of the tax shown on the prior year’s tax return - $24,000. To determine how much Taxpayer must pay in estimated taxes, Taxpayer would multiply $24,000 by 25%, which equates to $6,000 per installment. Thus, Taxpayer must pay estimated tax payments of $6,000 by April 15th, 2019, June 15th, 2019, September 15th, 2019, and January 15th, 2020.

Dishonored Check or Other Form of Payment

Under IRC § 6657, if the taxpayer’s check is dishonored or any other form of payment is not accepted, there shall be paid as a penalty an amount equal to 2% of the amount paid if that amount was $1,250 or more. If the amount paid was less than $1,250, the penalty shall be the lesser of $25 or the amount of the payment. For example, if Taxpayer attempted to pay $5 via a bad check to the IRS, the Taxpayer would be subject to a penalty of $5 because the amount paid was less than $1,250 and is the lesser of $5 or $25.