The IRS has over 140 penalty provisions at its disposal, but only use a handful regularly. The United States income tax system has a pay-as-you go structure. Simply stated, if you don’t pay enough federal tax throughout the year as you earn income, either by payroll withholding or quarterly estimated payments, you may face consequences. On top of underpayment penalties, there are also failure-to-file and failure-to-pay penalties, known as the delinquency penalties, associated with untimely-filed returns.

According to IRS statistics, more than one in ten taxpayers requested an extension to file their 2018 federal tax returns. With all the new tax code changes implemented in 2018, many taxpayers needed additional preparation time. The complexity of the new laws made it very difficult at extension time to estimate whether a taxpayer would expect a refund or owe more.

If you file Form 4868 by April 15, 2020, you will allow yourself an extra six months to prepare your 2019 income tax return. However, this extension period does not include additional time to pay taxes. If you figure you owe taxes, you must still pay by the original April 15 deadline. If you fail to cover your final amount due at that time, the unpaid balance will be subject to interest and a 0.5% per month late payment penalty. Interest accrues quarterly at a varying rate from the original due date until the date of payment. The combined rate for the penalty and interest is roughly 12% per year, and none of it is deductible. In other words, the October 15 federal tax extension deadline is only for filing your tax return, and you must gather enough information to determine taxes owed by April 15. It is better to slightly overestimate taxes because you will get any overpayment back in the end.

If you are one of the fifteen million taxpayers estimated to file extensions for the 2019 tax year, make sure to file timely even if you can’t pay your taxes in full at the original due date. If you owe, the fine for failing to file either an extension or a tax return by April 15 is 5% per month for five months, maxing out at 25%. It is always in your best interest to not ‘borrow money’ from the IRS, but rather pay as much as you can, as soon as you can, to minimize additional government charges. There are payment plans available through the IRS. If you pay within 120 days, you will not be liable for user fees. If a long-term installment agreement is approved, you will be assessed setup and processing fees. Individuals with balances over $25,000 and businesses with balances over $10,000 must use Direct Debit to pay their bills.

Generally, most taxpayers can avoid the accumulation of penalties if they owe less than $1,000, or if they paid at least 90% of the current year’s tax or 100% (110% if adjusted gross income was $150,000 ore greater) of the prior year’s tax. There are also certain qualifying life events that the IRS will consider for waiving a penalty. If you receive income unevenly during the year, you can potentially justify using an annualized installment method to reduce penalties as well. Another option to possibly erase penalties is the agency’s first-time penalty abatement program.

Please contact your Ketel Thorstenson tax advisor to help plan for these types of penalties.