Filing & Owing is Better Than Not Filing & Owing
If you owe taxes, the Internal Revenue Service will calculate penalties and interest on the amount owed. If you have a refund, the IRS may pay you interest on the delayed refund. (Note the difference between “will” and “may” – the IRS generally pays interest on refunds that have been delayed because of slow processing by the IRS. Since most late tax returns take longer to process, the IRS “may” pay you interest on based on the extra amount of time it takes them to process your return.) If you have a refund, there is no penalty for filing late. Penalties are calculated on the amount due. Since there is no amount due, there is no penalty. If you have a balance due on a late tax return, the IRS will calculate additional penalties and interest.
There are three separate penalties:
- Failure to File Penalty
- Failure to Pay Penalty
Each is calculated differently. Let’s take a look at each one.
Failure to File Penalty
The failure-to-file penalty is calculated based on the time from the deadline of your tax return (including extensions) to the date you actually filed your tax return. The penalty is 5% for each month the tax return is late, up to a total maximum penalty of 25%. The percentage is of the tax due as shown on the tax return. If your tax return is more than five months late, simply multiply your balance due by 25% to calculate your failure to file penalty.
Failure to Pay Penalty
The failure-to-pay penalty is calculated based on the amount of tax you owe. The penalty is 0.5% for each month the tax is not paid in full. There is no maximum limit to the failure-to-pay penalty. The penalty is calculated from the original payment deadline (the original April 15th filing deadline) until the balance due is paid in full.
Interest is calculated based on how much tax you owe. Interest rates change every three months. Currently, the IRS interest rate for underpayment of tax is 5% per year. The interest is calculated for each day your balance due is not paid in full. IRS interest rates are variable and are set quarterly.
Action Plan Items
There’s a lesson to be learned by looking at the penalties. If you owe, it is better to file sooner rather than later. Also, if it looks like you are going to be a few months late on your next tax return, file an extension. By filing an extension you may reduce or eliminate the Failure to File Penalty.