IN THIS ISSUE: Individual Estimated Tax & Penalties for Late Payment or Filing
Have you wondered what penalties are applied by the IRS if you fail to file your income tax return on time (without qualifying for a filing extension) or if you fail to pay your taxes on time?
Penalties for Late Payment or Filing
Failure to pay:
Separate penalties apply for failing to pay and failing to file. The failure to pay penalty is the “gentler” of the two, running at 1/2% for each month (or part of a month) the payment is late. For example, if payment is due April 15 and is made May 20, the penalty is 1% (1/2% times 2 months (or partial months)). The maximum penalty is 25%.
The failure to pay penalty is based on the amount shown as due on the return (less credits for amounts already paid, e.g., via withholding or estimated payments), even if the actual tax bill turns out to be higher. On the other hand, if the actual tax bill turns out to be lower, the penalty is based on the lower amount.
For example, if your payment is two months late and your return shows that you owe $5,000, the penalty is 1% (see above), which equals $50. If you are audited and your tax bill increases by another $1,000, the failure to pay penalty is not increased because it’s based on the amount shown on the return as due. On the other hand, if the audit reveals that your tax due should have only been $4,000, the penalty is reduced to $40.
Failure to file:
The failure to file penalty, also known as the delinquency penalty, runs at the more severe rate of 5% per month (or partial month) of lateness to a maximum of 25%. If you obtain an extension for your filing due date, you are not filing late unless you miss the extended due date. However, a filing extension does not apply to your responsibility for payment.
If the 1/2% failure to pay penalty and the failure to file penalty both apply, the failure to file penalty drops to 4.5% per month (or part) so the total combined penalty remains at 5%. The maximum combined penalty for the first five months is 25%. Thereafter the failure to pay penalty can continue at 1/2% per month for 45 more months (an additional 22.5%). Thus, the combined penalties can reach a total of 47.5% over time.
The failure to file penalty is also more severe in that it is based on the amount required to be shown on the return, and not just the amount shown as due. (Credit is given for amounts paid, for example, via withholding or estimated payments. So if no amount is owed, there is no penalty for late filing.) Thus, for example, if a return is filed three months late showing $5,000 owed (after payment credits), the combined penalties would be 15%, which equals $750. If the actual tax liability is later determined to be an additional $1,000, the failure to file penalty (4.5% × 3 = 13.5%) would also apply to this amount for an additional $135 in penalties.
A minimum failure to file penalty will also apply if you file your return more than 60 days late. In this case, the failure to file penalty is at least $135. Even here, however, if you owe no taxes, there is no penalty.
Both penalties may be excused by IRS if your lateness is due to “reasonable cause.” Typical qualifying excuses include death or serious illness in the immediate family, postal irregularities, or bad advice (e.g., you needn’t file), given to you by your tax advisor or IRS itself. If you have questions on whether your particular situation could qualify as reasonable cause, please call.
Interest is assessed at a fluctuating rate announced by the government apart from and in addition to the above penalties. Furthermore, in particularly abusive situations involving a fraudulent failure to file, the late filing penalty can jump to 15% a month, with a 75% maximum.
The American Taxpayer Relief Act of 2012 affected a number of tax forms and revising those forms required extensive programming and testing of IRS systems, which delayed IRS’s ability to release, accept, and process those forms. Since those delays affected some taxpayers ability to timely estimate and pay their 2012 tax liability when requesting an extension to file, the IRS provided transitional relief.
Generally, IRS automatically assesses the failure to pay penalty against taxpayers who pay late, and then it sends notice and demand for payment of the addition to tax.
Individual Estimated Tax
Why it is necessary for you to make estimated tax payments and the applicable rules for paying the minimum amount of estimated tax without triggering the penalty for underpayment of estimated tax?
Individuals must pay 25% of a “required annual payment” by Apr. 15, June 15, Sept. 15, and Jan. 15, to avoid an underpayment penalty. (When that date falls on a weekend or holiday, the payment is due on the next business day.) The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. Certain high-income individuals must meet a more rigorous requirement. If the adjusted gross income on your previous year’s return is over $150,000 (over $75,000 if you are married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.
Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employer from their paycheck.
If you fail to make the required payments, you may be subject to an underpayment penalty. The penalty equals the product of the interest rate charged by IRS on deficiencies, times the amount of the underpayment for the period of the underpayment. The penalty is avoided if you meet certain specified exceptions or waivers, described below.
Most individuals make estimated tax payments in four installments. In other words, we determine the required annual payment, then divide that number by four and make four equal payments by the due dates. But you may be able to make smaller payments under the annualized income method. This method is useful to people whose income flow is not uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business that you operate in a resort area during June, July, and Aug., no estimated payment is required before Sept. 15. You may also want to use the annualized income method if a significant portion of your income comes from capital gains on the sale of securities which you sell at various times during the year.
The underpayment penalty doesn’t apply to you:
- If the total tax shown on your return is less than $1,000 after subtracting withholding tax paid.
- If you were a U.S. citizen or resident for the entire preceding year, that year was 12 months, and you had no tax liability for that year.
- If you are a farmer or fisherman and pay your entire estimated tax by Jan. 15 of the following year, or pay your entire estimated tax by Mar. 1 of the following year and also file your tax return by that date.
- If for the fourth (Jan. 15) installment, if you aren’t a farmer or fisherman, file your return by Jan. 31 of the following year, and pay your tax in full.
In addition, IRS may waive the penalty if the failure was due to casualty, disaster, or other unusual circumstances and it would be inequitable or against good conscience to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled.