Penalties for Underpayment or Late Returns

What happens if you don't file a tax return or pay taxes that you owe by their due date? Generally, in this situation the IRS will send you a notice hitting you with interest and penalties.

Interest. The IRS will charge you interest on taxes not paid by their due date, even if you've been granted an extension of time to file your return. The interest rates for most taxpayers are based on the federal short-term rate plus three percentage points. The most recently announced interest rate on underpayments of tax is 3 percent.

Interest is also charged on the penalties imposed for failure to file a return as well as other penalties imposed for negligence, fraud, etc. This interest is charged on the penalty from the due date of the return, including extensions.

Penalties. If you pay your taxes late, the penalty is usually 0.5 percent of the unpaid amount for each month or part of a month the tax is not paid. The penalty can't be more than 25 percent of the unpaid amount and applies to any unpaid tax on the return. Please note, this penalty is in addition to the interest charged for late payments.

The IRS will also hit you with a penalty if you file your return late. If you don't file your return by its due date (including extensions), the penalty is usually 5 percent of the amount due for each month or part of a month your return is late, unless you have a reasonable explanation. If you think you have a reasonable explanation, write it down in a statement and attach it to your return, and you might be able to avoid the penalty. In any case, the penalty usually can't be more than 25 percent of the tax due. However, if your return is more than 60 days late, the minimum penalty will be $100 or the amount of any tax you owe, whichever is smaller.

Tip Generally, corporations are subject to the same rules as individuals. However, corporations are also subject to penalties if they don't deposit taxes or deposit them after the due date. Deposits of tax after the due date are subject to a penalty on the underpayment. The underpayment is the excess of the required tax deposit over the tax deposited by the due date.

Estimated tax penalty. What happens if you underpay your estimated tax? You may have to pay a penalty in the form of interest on the underpayment for the period when the underpayment occurred. The penalty is figured separately for each payment period, and you may owe a penalty for an earlier payment period even if you later paid enough to make up the underpayment.

As a matter of fact, if you didn't pay enough tax by the due date of each of the payment periods, you may owe a penalty even if you are due a refund from the IRS when you file your income tax return.

Example Cherilyn is employed as a teacher and runs her own tutoring business as well. She didn't make any estimated tax payments during last year because she thought she had enough tax withheld from her teaching wages. Early in January this year, she estimated her total last year's tax and realized that her withholding was $2,000 less than the amount needed to avoid a penalty for underpayment of estimated tax. So on January 11 of this year, Cherilyn made an estimated tax payment of $2,000, the difference between her withholding and her estimate of her total tax. When she files her final return for last year, Cherilyn's total tax is $50 less than she originally figured, so she is due a refund from the IRS. However, Cherilyn will owe a penalty through January 11 of this year for her underpayments for the first three quarterly payment periods. She won't owe a penalty for the fourth quarter because she made a payment for the quarter by the January 15 due date.

You can request a waiver of the penalty if the underpayment was caused by a casualty, disaster, or some other unusual circumstance that would make its imposition unfair. The IRS may also waive the penalty for reasonable cause during the first two years after a taxpayer retires upon reaching age 62 or becomes disabled. Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, must be filed to request a waiver.

You can use Form 2210 to calculate your estimated tax penalty. But this form is very complicated, and generally, you aren't required to complete it. When you file your tax return, the IRS will usually figure the penalty for you and send you a bill. Depending on what you pay your tax pro, it may be more beneficial to you to let the IRS do the calculations. What other situations might require you to file Form 2210? Other than when you request a waiver, you must file Form 2210 when:

• You use the annualized income installment method.
• You use your actual withholding for each payment period for estimated tax purposes.
• You base any of your required installments on the tax shown on the previous year's return and you filed or are filing a joint return for either that previous year or the present year, but not for both years.

Corporations must use Form 2220, Underpayment of Estimated Tax For Corporations, to determine any underpayment of the corporation's estimated tax. Corporations generally don't have to file Form 2220--the IRS will figure any penalty and bill the corporation. However, corporations must file Form 2220 if:

• The corporation used the annualizing or recurring seasonal income method to determine any installment required.
• The corporation is a large corporation computing its first required installment based on the prior year's tax.