Although for some, filing their tax return to obtain a refund is a priority, there are those who procrastinate until the last minute, often missing the deadline for filing. For some, this has not been a problem over the years as they ended up receiving refunds for overpaid taxes. However, under the new tax law, many were surprised in that not only were their refunds lower than in prior years, they actually owed money, and of course late penalties and interest. To avoid such costly situations, we urge clients to begin compiling their tax information in December (unless self employed or with income without withholding tax, in which case this is a year round process with quarterly estimated tax payments due). Although documents from third parties are not received until the new year, we suggest that a list of all income sources be prepared and maintained so you know what documents to look for.
Although the brokerage firms are much better now that they have been recording the client’s cost basis for securities held and sold, there are times when investment shares are transferred from other accounts, sometimes these are inherited investment shares with no record of purchase or cost. This requires lengthy legwork in order to determine gain or loss, and if left to the last minute, can cause the tax return to be filed late. In cases where the returns are put off and never filed, the IRS can not only file a substitute return based on third party information, IRS will not account for cost basis and over assess tax (and penalties and interest). The IRS can enforce collection procedures regardless of whether the tax is right or wrong. And if there is a tax overpayment, after three years the IRS does not have to (and won’t) refund the money, nor will they apply it to subsequent returns that show a balance due. So for those returns, thee is the additional tax owed, plus a hefty penalty and interest charge, with no offset for refunds for prior year returns not filed.
The normal penalties are listed below. In cases where a return is filed but third party information shows that additional income was paid and not reported by the taxpayer, often the IRS computer will assess a 20% Accuracy Related Penalty (sometimes as high as 40%).
According to the IRS website, interest and penalties (other than the ARO (above) are as follows:
INTEREST: When you file your tax return late, you’ll be charged interest on any unpaid balance and you may also be subject to failure-to-file and failure-to-pay penalties. Interest accrues on the unpaid balance and compounds daily from the due date of the return (without regard to any extension of time to file) until you pay the balance in full. The interest rate for taxpayers other than corporations is the federal short-term rate plus 3%. The federal short-term rate is determined every three months. For the current quarterly interest rate on underpayments, search “interest rates” in Newsroom Search or “quarter interest rates” on IRS.gov.
Failure-to-pay penalty is charged for failing to pay your tax by the due date. The late payment penalty is 0.5% of the tax owed after the due date, for each month or part of a month the tax remains unpaid, up to 25%. You won’t have to pay the penalty if you can show reasonable cause for the failure to pay on time, however the reasonable cause exceptions are extremely limited but at the end of the day, it is really up to the discretion of the IRS agent from whom you request penalty relief. Note that there is a magic wand (or silver bullet) for those who were never assessed a late penalty before and this is a first time penalty. In that case, there is no reasonable cause required. It is a first time “mulligan” . Then there are additional penalties if the IRS sends you a notice before you file, and those notices are ignored. . 10 days after the IRS issues a final notice of intent to levy or seize property, the 0.5% rate increases to 1% per month. The penalty rate is 0.25% for each month or part of a month in which an installment agreement is in effect. Failure-to-file penalty is charged on returns filed after the due date or extended due date, absent a reasonable cause for filing late. The failure-to-file penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late. The penalty won’t exceed 25% of your unpaid taxes. If both a failure-to-file and a failure-to-pay penalty are applicable in the same month, the combined penalty is 5% (4.5% late filing and 0.5% late payment) for each month or part of a month that your return was late, up to 25%. The late filing penalty is calculated based on the tax that remains unpaid after the due date. Unpaid tax is the total tax shown on your return reduced by amounts paid through withholding, estimated tax payments, and allowed refundable credits. If after five months you still haven’t paid, the failure-to-file penalty will max out, but the failure-to-pay penalty continues until the tax is paid, up to 25%. The maximum total penalty for failure to file and pay is 47.5% (22.5% late filing and 25% late payment) of the tax. If your return was over 60 days late, the minimum failure-to-file penalty is the smaller of $210 (for tax returns required to be filed in 2019) or 100% of the tax required to be shown on the return.
So be smart, always file your tax return in a timely manner and even if you anticipate not being able to file on time (with or without an extension), prepay the entire tax due as no penalty can be assessed against a return where the tax is overpaid. Be cautions though, as even though you may show a tax overpayment that includes credit for taxes overpaid and applied from a prior year, if there is a problem with the prior year tax return that eliminates that overpayment, you can find yourself short in the current year.
If you don’t have the money to pay the tax owed on the tax return and you qualify for an installment payment plan, file on time and attach an installment payment plan request. You will pay a fee for this and continue to pay interest and penalties, but at least you will be current and the IRS collection enforcement will not be hounding you. They key is to file on time and pay back the tax owed as soon as possible to minimize the penalties and interest. As a very last ditch, if you don’t qualify for an installment plan, it is always best to file a tax return without the payment and then pay the tax owed as soon as possible. At least you avoid the hefty 4.5% monthly late filing penalty and only left with the .5% per month late payment fee.