At Weech Financial, we strive to keep our clients in compliance with tax return filing and tax payment deadlines. Occasionally, however, we have clients that, for one reason or another, fail to file their returns by the specified deadlines or to make necessary tax payments in a timely fashion. The IRS has legal authority to do so, and often does assess various penalties and interest on late filed returns or late payments. This is not a good situation to be in and no one likes to or needs to pay unnecessary penalties or interest. I will briefly discuss the types of penalties assessed by the IRS as well as describe how these penalties and interest work in this month’s post.
Basically, there are three types of penalties that the IRS can assess related to an income tax return – estimated tax payment penalties, late filing penalties and late payment penalties. Let’s first discuss estimated tax payment penalties. Assuming that your withholding from wages or retirement plan distributions are not sufficient to cover your tax liability for a given year, you are required to make quarterly estimated income tax payments to cover the remaining tax liability. Most taxpayers can avoid these penalties if the amount they owe when filing their return is less than $1,000 or if they paid in at least 90% of the current year tax liability or 100% of the total tax liability from the prior year. If you fail to make the requisite payments each quarter and for the tax year as a whole, the IRS will assess estimated tax penalties on the amount you should have paid in and that will show up on your income tax return for the year. Estimated payment penalties are based on the underpayment amount for each quarter of the year and the number of days that the payment remains unpaid. Estimated tax penalties may apply even if your tax return shows an over payment of tax for the year as a whole. This can result from not paying in your tax liability in equal increments each quarter during the year. The estimated tax penalty rate is based on current IRS interest rates and is currently 3%.
The next penalty we will discuss is the late filing penalty. This penalty comes into play if a tax return is not filed by the original or extended deadline for that return. The original filing deadline for corporations is March 15th and the original deadline for partnership and individual returns is April 15th. Both business and individual returns can be extended and, if so, the extended deadlines are September 15th for partnership and corporate returns and October 15th for individual returns. If no return or extension is filed by the original deadline, late filing penalties will be assessed and will accrue from the original filing deadline until the return is filed. If a return is successfully extended and no return is filed by the extended deadline, late filing penalties will be assessed and accrue from the original filing deadline as if no extension had been granted. When we extend a tax return and are approaching the extended deadline with no hope of finalizing the return by that deadline, we will often file a preliminary return with the best information we have available by that final deadline in an attempt to avoid the late filing penalty and then amend the return later, if necessary. As long as the income reported on the initial return filed is not substantially understated, this strategy will work to avoid this penalty. Keep in mind that if no tax is due on a C-corporation or individual return, no late filing or late payment penalty will be assessed as the penalty is based on how much tax is due and not paid. However, information returns such as partnership and S-corporation returns (flow-through entities where any tax due is paid at the individual level) will have a late filing penalty assessed if filed late regardless of whether tax is due at the individual level. Entity taxpayers such as this can obtain abatement of the late filing penalty for these returns once if this was their first offense of late filing. I will not address how late filing penalties are calculated for partnerships and S-corporations in this post. The late filing penalty for individuals is calculated as 5% of the unpaid taxes for each month or part of a month that a tax return is late but can’t exceed 25% of your unpaid taxes. This penalty is much harsher than the late payment penalty that we will discuss next so it makes sense to ensure that your return is filed timely even if you can’t pay the full tax amount due.
The late payment penalty is assessed on any tax amount due for a given tax year that is not paid by the original due date of that return. The granting of an extension to file your tax return does not extend the time by which you must pay your tax liability. This is why it is important to pay as much of your liability as you can by the original due date of the return. I might add that delaying the filing of your tax return will not, in any way, change the end result as it relates to late payment penalties. Some clients have asked that we not file their completed returns by the original deadline in hopes that this will somehow reduce their late filing penalty. In reality, it doesn’t make any difference in the end if we file the completed return by the first deadline or extend the return – the late payment penalties will be the same either way. The late payment penalty is generally .5% per month of your unpaid taxes and applies for each month or part of a month that your taxes remain unpaid. This late payment penalty can build up to as much as 25% of your unpaid taxes.
Lastly, interest is assessed on any unpaid tax liability that remains after the original due date of the return. The calculation is simply the balance of tax unpaid after that date multiplied by the federal interest rate in effect for each quarter thereafter until the balance is paid in full. The federal interest rate can change each quarter but the rate is currently 3%. Fortunately, the IRS will also pay interest to taxpayers at this rate for any delayed refunds paid to taxpayers in many cases.
Now that you know how these penalties are assessed and when they are assessed, you can take the steps necessary to avoid them altogether! If you have any questions, please don’t hesitate to contact us.