Because I specialize in the preparation for unfiled tax returns, I hear this question a lot. When it comes to taxes, putting off filing returns and paying the taxes can be costly, quickly. However, not all late filings will incur penalties. Let’s break down how the IRS calculates penalties and interest, and then I’ll give you some rules of thumb so you can quickly get a ballpark of interest and penalties for your situation.
Late Filing vs. Late Payment: Understanding the Difference
The IRS imposes separate penalties for Late Filing of returns and Late Payment of taxes.
- Late Filing (Failure-to-File) Penalty:
- 5% of the unpaid taxes for each month (or part of a month) that your return is late, up to a maximum of 25%.
- If your return is over 60 days late, the minimum penalty is $435 or 100% of the unpaid taxes, whichever is less.
- Late Payment (Failure-to-Pay) Penalty:
- This penalty is 0.5% of the unpaid taxes for each month (or part of a month) that the taxes remain unpaid, up to a maximum of 25%.
If both penalties apply, the IRS reduces the failure-to-file penalty by the amount of the failure-to-pay penalty during the same period.
Interest Charged on Unpaid Taxes
On top of the penalties, the IRS also charges interest on any unpaid taxes starting from the due date of the return (April 15th) until the balance is paid completely. The interest rate is adjusted quarterly, based on the federal short-term rate.
Rules of Thumb
How much will the Penalties and Interest be for me? In order to give you a quick way to get a ballpark amount of what to expect, I’ve calculated yearly amounts.
- File 1 year late, total Penalties & Interest will be 32% of tax due.
- File 2 years late, total Penalties & Interest will be 38% of tax due.
- File 3 years late, total Penalties & Interest will be 50% of tax due.
- File 4 years late, total Penalties & Interest will be 62% of tax due.
- File 5 years late, total Penalties & Interest will be 75% of tax due.
Example: Tax return filed 1 ½ years after the due date. The tax due on the return is $2,500. We take the $2,500 and multiply it by the approximate half way point of the 2 years late rule of thumb, 35%. $2,500 x 35% = $875. The penalties and interest in this example will be approximately $875.
What Happens If You’re Due a Refund?
Good news! If you’re owed a refund and file your tax return late, the IRS does not impose any penalties. This is because penalties are calculated on unpaid taxes. If no taxes are owed, no penalty or interest.
However, there is a catch. The IRS has a three-year statute of limitations for claiming a refund. After the three-year deadline, your refund becomes property of the U.S. Treasury.
Strategies to Minimize Penalties and Interest
- File on Time, Even If You Can’t Pay:
- Filing your return on time avoids the HUGE Late Filing penalty.
- If you can’t pay the full amount, pay as much as you can to minimize interest and the Late Payment penalty.
- Request an Extension:
- An extension gives you an additional six months to file your return, BUT it doesn’t extend the time to pay your taxes.
- Set Up a Payment Plan:
- If you owe taxes and can’t pay in full, the IRS offers installment agreements to help you manage the debt.
- Consider Penalty Abatement:
- If you’ve always filed and paid on time in the past, you may qualify for Penalty Abatement.
Note: While penalties may be waived in certain circumstances, interest will not be waived.
The Bottom Line
Late filing and payment of your taxes is expensive, but the IRS has clear rules and ways to minimize the cost. If you’re unsure about your tax situation or need help navigating the complexities, Tax Rescue CPA is here to help you stay compliant and minimize your tax burden.
“Who’s Doing Your Taxes?” – Tax Rescue CPA