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How Does the IRS Calculate Penalties and Interest?

Late payment of employment taxes will trigger penalties and interest charges to the taxpayer. The notices for an IRS late tax penalty are next to impossible to decipher.

Statute of Limitations

There is NO statute of limitations on the failure to file and report payroll taxes (Social Security, Medicare, Unemployment, withheld income taxes). There also is no statue of limitations on assessment of tax, penalties and interest when a false tax return is filed. Household employment taxes are remitted with the employer’s personal 1040 income tax return. Any household employer who did not pay these taxes has de jure submitted a false tax return, and thus are subject to a penalty for not paying taxes.

Types of IRS Penalty Charges

— Late Filing Penalties

If you owe tax and don’t file on time, according to IRS regulations, penalties are assessed and added to your bill. Penalties are in addition to BOTH the tax due and the interest on the past due tax. The total penalties for filing taxes late is usually 5% of the tax owed for each month, or part of a month, that your return is late up to five months (25%). If your return is over 60 days late, the minimum penalty for late filing is the smaller of $100 or 100 percent of the tax owed.

— Late Payment Penalties

If you file on time but don’t pay all amounts due on time, you’ll generally have to pay a late payment penalty of one–half of one percent (0.5%) of the actual tax owed for each month, or part of a month, that the tax remains unpaid from the due date, until the tax is paid in full. There is no maximum limit to the failure-to-pay penalty.

Failure to Pay Penalty

If you fail to pay your taxes, the IRS will penalize you based on how long your overdue taxes remain unpaid. The penalty will be a percentage of the taxes you either didn’t pay or didn’t report on your return. The IRS charges 0.5% of your unpaid taxes for each month or part of a month that your taxes remain unpaid. The failure to pay penalty has a maximum charge of 25% of your unpaid taxes. 

Be sure to pay your taxes within 10 days of the failure to pay notice. After 10 days, the penalty charge increases to 1%.

Underpayment of Estimated Tax

The underpayment of estimated tax penalty can apply to individuals or corporations. In both cases, the penalty is issued when the individual or corporation fails to pay the estimated amount of tax on their income or the payment is late. The penalty is calculated based on the underpayment, when the payment was due and underpaid and the quarterly interest rate for underpayments. 

Accuracy-Related Penalties

Accuracy-related penalties occur when an individual claims deductions they don’t apply for or doesn’t report all their income. There are two common examples of this:

  • Negligence or disregard of the rules or regulations: An individual can receive this penalty if they don’t make a reasonable attempt to follow tax return laws or if they intentionally ignore the tax laws when filing their return. 
  • Substantial understatement of income tax: An individual receives this penalty when the tax shown on their return is understated by 10% or $5,000 depending on which amount is larger. 

Dishonored Checks

The dishonored check penalty is issued if an individual’s bank account lacks sufficient funds to make a payment. The bank will return and dishonor an electronic payment or check and the amount will be declared unpaid. In this case, the cost of the penalty is the payment amount or $25 if the payment amount is less than $1,250, or 2% of the payment amount if it is more than $1,250.

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Interest Charges

The IRS will charge interest on late or unpaid taxes, regardless of cause. The period covered always begins with the original due date of the return, and ends with the receipt of payment by the IRS. You may incur interest expenses for late filing, or simply for making a mathematical error on your tax return.

Generally, interest is charged on any unpaid tax from the original due date of the return until the date of payment. The interest rate on unpaid Federal tax is determined and posted every three months. It is the federal short–term interest rate plus 3 percent.  Interest is compounded daily.  Currently the rate is 8%*.

*Updated April 2024

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Abatement of IRS Penalties and Interest

The IRS will require that penalties and interest be paid in full before any abatement determination is made. Once you pay the bill, the ‘meter’ stops and you will not have additional interest charges accruing.

As a general rule of thumb, you may request an abatement of penalty if you show cause. Interest on late tax payments may not be abated except in extraordinary circumstances. Interest abatement almost always requires that the taxpayer prove an undue delay by an Internal Revenue Service staff member is the cause, in part, of the interest.

A taxpayer who voluntarily steps forward and corrects a deficiency in a previously filed return (NOT DISCOVERED IN AN AUDIT!) is often successful in requesting penalty abatement.

To request an abatement of penalty, write to the IRS office that issued the bill within the time frame provided by the IRS. Be certain to clearly and concisely describe the cause and provide any supporting documentation you might have. We have had many clients be successful in having late payment penalties abated with a statement as follows:

“A bookkeeping error resulted in an under reporting of wages for the [PERIOD]. I (We) immediately and voluntarily corrected the record and paid the taxes due once the error was discovered. I (We) recognize that interest on the late taxes is due. However, I (We) respectfully request that the late filing penalty be abated.”

We have found that the IRS adjustment process takes 30 – 60 days from when the abatement request is made.

» More Information: IRS Collection Process

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