There are three common penalties assessed against taxpayers: underpayment, late payment, and late filing. These penalties are fairly easy to avoid if you plan ahead. Generally, tax returns for individual taxpayers are due April 15th and any unpaid tax is also due. If you fail to meet this deadline, or you did not pay enough taxes during the year through Federal withholding or estimated tax payments, you may be liable for IRS underpayment of estimated tax, late payment, and/or late filing penalties in addition to any tax you owe.
Underpayment of Estimated Tax Penalty
Probably the most common type of penalty is the underpayment of estimated tax penalty. This can affect any taxpayer but most often impacts taxpayers who are not W-2 wage earners. Since income taxes are not directly withdrawn and remitted to the IRS during the year via payroll, the burden falls on the taxpayer to pay estimated tax payments through the year. These estimates must be paid in four equal quarterly installments which are due on April 15, June 15, September 15, and January 15.
The underpayment penalty consists of the interest on the underpaid amount for the number of days the payment is late. Interest is charged at the Federal rate for underpayments which is currently set at 3% for the first quarter of 2016 and 4% for the second quarter of 2016. Since estimates are required to be paid each quarter, you may be liable for an underpayment penalty even if all tax has been paid.
This underpayment penalty will generally not apply if the tax due, after subtracting any tax withheld, is less than $1,000 or the taxpayer had no tax liability for the prior year return that covered 12 months.
The IRS has provided a safe harbor to help taxpayers avoid these penalties. Individuals are subject to an underpayment penalty unless total withholding and estimated tax payments equal the smaller of:
- 90% of the tax shown on the current year tax return or
- 100% of the tax shown on the prior year tax return [110% if the taxpayer’s prior year adjusted gross income exceeded $150,000 ($75,000 for married taxpayers filing separately)].
There are special rules for farmers and fishermen so please contact us if at least two-thirds of your gross income is from farming or fishing.
Late Payment Penalty
If you do not pay the tax you owe by the April 15 filing deadline, you will most likely face a failure-to-pay penalty. The failure-to-pay penalty is .5% of the unpaid balance and applies for each month or part of a month after the due date. This penalty starts accruing the day after the filing due date. The penalty is capped at a maximum of 25% of the unpaid tax due.
If you timely requested an extension of time to file your individual income tax return and paid at least 90% of the taxes owed with the extension request, you may not face a failure-to-pay penalty. However, you must pay any remaining tax due by the extended due date (generally October 15).
Late Filing Penalty
One of the most punitive penalties is for failing to file your tax return on time when you owe tax. The failure-to-file penalty starts at 5% of your unpaid taxes for each month or part of the month the return is late. The penalty is capped at 25% of the unpaid balance due. There will be no penalty imposed if there is no tax due with the tax return filing. If you file your return more than 60 days after the due date or extended due date, the minimum penalty for late filing is the smaller of $135 or 100% of the unpaid tax.
The silver lining with the late filing penalty is that there is no reason to ever incur a late filing penalty. As long as you file an extension by the April 15th due date, you automatically get an additional 6 months to file the tax return. So even if you cannot pay the tax, you should still file a return or an extension.
If both the 5% failure-to-file penalty and the .5% failure-to-pay penalty apply in any month, the maximum penalty you will pay for the month will be 5%.
Penalties for late payment and late filing will not be imposed if the taxpayer can show that the failure was due to reasonable cause, rather than to willful neglect. Some of the reasonable cause requests that have been approved in the past include death or serious illness of the taxpayer or an immediate family member, unavoidable absence of the taxpayer on the filing due date, and the destruction of the taxpayer’s residence or business.