IRS Penalties & Interest
I often have clients ask things like, “What if I don’t pay my estimated tax payments,” “Can I make payments to the IRS on my bill,” or “I can’t pay my taxes now, can we extend?” My answer is usually you can do what you want regarding paying the IRS, just know that you may pay interest and/or penalties for not paying in enough or when you should. The next question is always, “How much are those?” The answer is there are several different types of penalties the IRS may charge.
If you have not paid in enough withholding throughout the year or in estimated payments on the scheduled due dates, you will be charged an underpayment penalty. The IRS deems withholding to be evenly through the year regardless of when it is withheld. If you are self-employed or have other sources of income in which you do not have withholding but would owe tax, then you should be paying estimated tax payments, depending on the safe harbor rules. The IRS says you are required to pay tax as the income is earned and not necessarily all at the end of the year.
That is how the estimated tax payment schedule was derived. Currently, as the rate changes each quarter potentially, the rate you will pay for an underpayment penalty is 7% annually so far for the year 2023. We do not know if this will change for the 4th quarter or not yet, so stay tuned.
Failure to Pay Penalty
If you get to the point of filing your tax return, but you do not have the ability currently to pay what may be due with the return, the IRS will charge a failure to pay penalty. That penalty is calculated at 0.5% for each month or part of a month you are late, up to a maximum of 25%. This is calculated on the amount of tax that remains unpaid from the due date of the return (and payment) until the tax is paid in full.
The IRS will also charge interest on any unpaid tax from the due date of the return and the amount of payment due until the tax is paid in full. The interest rate charged is determined quarterly and varies based on the federal short-term rate plus 3%. Interest will compound daily until all tax due is paid. As of the writing of this article, the announced interest rates charged for 2023 are 7% annually for underpayment of taxes for individuals.
Failure to File Penalty
Finally, the failure to file penalty. This is charged if you have tax due, and you have not filed your return on time. Extending your return only extends your time to file, not your time to pay. While you may have to pay an underpayment penalty and interest, you do not have to pay the failure to file penalty if your return has been properly extended by the filing due dates. KT (Ketel Thorstenson,) tries to make sure our clients never pay this because a failure to file penalty is expensive. It is 5% of the tax owed 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, there is also a minimum penalty incurred which is the lessor of $450 for returns filed in 2023 or 100% of the tax owed.
As you can see, there are several reasons to be sure you have paid and filed your taxes on time, including extensions. With interest rates on the rise this has become a much bigger topic than when rates were low. Now, these charges are accruing much more quickly.
Remember, every situation is different, so be sure to contact your KT tax advisor if you have any questions.