This article is a resource included in our course, Dealing with IRS Tax Debt. It’s a class designed to help individuals resolve their tax debts on their own, saving thousands of dollars in representation costs. The course covers everything most filers need to know to deal with the IRS effectively, including penalties commonly assessed on unpaid taxes.
This article discusses the most common penalty assessed on unpaid tax, the Late Payment Penalty. It will also introduce the late Payment Penalty’s cousin, the Estimated Tax Penalty. As you will see, calculating penalties on past-due taxes can be complex. If you’re concerned about a math test, don’t worry. Our goal isn’t your ability to double-check IRS computers (even though they’re wrong quite often). It’s to help you understand enough to avoid their imposition, and, as detailed Dealing with IRS Tax Debt, knowing how to have them removed (in tax-speak, abated).
The Late Payment Penalty
The Late Filing Penalty (also called Failure to Pay) is a penalty imposed by the Internal Revenue Service for paying a tax after its due date. This due date is generally April 15th – the nonextended due date of your tax return. The late payment can get imposed even when you file an extension. An extension provides additional time to file your tax return, not – with limited exception discussed below – to pay your tax. However, filing an extension is essential for several reasons – most notably, avoiding a far more sinister penalty, the Late Filing Penalty (covered in another lesson).
As mentioned, the April 15th due date is a general rule, but it does not apply in many circumstances. For instance, in 2020 and 2021, congress changed the April 15th filing – and tax payment - deadline due to the COVID pandemic.
Late Payment Extension Wrinkle: Here’s another quirk in the late payment penalty and April 15th relationship. Suppose you file an extension by the original due date (usually April 15th) AND have already paid at least 90% of the tax due on that return. In that case, you may not be subject to the late payment penalty on the remaining balance. If you pay the remaining 10% balance due by the extended due date, you can avoid the Late Payment Penalty. You will, however, still owe interest on the balance.
How Much is the Late Payment Penalty? As the name suggests, the late payment penalty gets imposed when you pay your taxes late. The penalty is ½ of 1% (.005) of the tax due. It gets assessed each month, or PART of a month the tax remains outstanding. The Late Payment Penalty caps at 25% of the unpaid tax. Once it reaches 25%, calculation and assessment cease.
Limit on Dual Penalty Penalties: The Late Filing Penalty (discussed in another lesson) is a monthly penalty of 5% of the tax owed. For those who owe both the Late Payment Penalty and the Late Filing Penalty for the same month, the maximum penalty imposed is 5%. Since the late Late Payment Penalty is 0.5%, you get a lucky break – the IRS discounts the Late Filing Penalty to 4.5% for that month, so the total of both is 5%!
Estimated Tax Payment Penalty
As mentioned above, the April 15th penalty deadline is not a hard-and-fast rule. Another situation where it may not apply in penalty calculation is when estimated taxes payments are required. Failure to make estimated tax payments can result in the levy of the Estimated Tax Penalty. This penalty is rooted in the US tax structure being a “pay as you go” (or earn) system. Taxes, generally speaking, get remitted as taxpayers receive taxable income. For example, consider how employee taxes get withheld from paychecks. Employers withhold taxes every time employees get paid. The higher the check, the more tax is withheld. When earnings fall, less tax gets withheld.
Estimated tax payments come into play when there is not enough tax withheld to cover tax due on the return. Individuals in this situation (who are often self-employed) may be required to make tax payments throughout the year in the form of estimated tax payments. These payments are also referred to as quarterly tax payments, although that’s not entirely accurate. Remittance is generally due four times per year, but not every three months. These dates are April 15th, June 15th, September 15th, and January 15th of the following year.
When Estimated Taxes are Required: Here’s a basic rundown on estimated tax requirements. Not following these rules can result in the Estimated Tax Penalty.
Those who owe $1,000 or more with their tax return must have paid (through estimated tax payments and withholding) either:
How is the Estimated Tax Penalty Calculated: The Estimated Tax Penalty takes the form of interest applied to the amount taxpayers should have remitted each quarter. The rate is equal to the federal short-term rate plus 3%. Although this rate may not seem high, it is a compounding rate, meaning interest gets added to the balance due. Interest then calculates the entire amount owed - tax plus accumulated interest. The Estimated Tax Penalty also compounds daily, which grows a little faster than interest compounded monthly.
Take away: There are quite a few penalties taxpayers can face on unpaid taxes. The most common are the late payment and late filing penalties. The Estimated Tax Penalty also comes into play for those required to make them. And, of course, let’s not forget the interest that accrues on the whole kit and kaboodle.
Understanding these penalties – why and when they get assessed – is key to your IRS Strategy. If you owe back taxes or know someone who does, we hope you review our training course. It is the product of 20+ years of helping clients manage their tax obligations. Most students can handle their tax debt independently, with a bit of instruction, and save thousands of dollars in representation fees. You owe it to yourself to check it out!
All courses and articles are for informational purposes only and do not constitute tax advice. Taxes are complicated - do not act on course information without consulting a professional. Always refer to treasury regulation before making any tax decision. Read the full disclaimer.
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The course was excruciatingly detailed, which I appreciate. I definitely recommend this course to anyone who even thinks they may need it.- Greg, Brookfield, IL, 1099-MISC Basics Course