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With the 2023 filing season under way, taxpayers who owe tax with their 2022 tax return may be reluctant to file their returns by April 18 or may consider an extension to file. Taxpayers should know the consequences of late filing and payment.
The IRS will assess a failure-to-file penalty when a tax return is not filed by the due date or the date of a valid extension to file. A penalty of five percent of the unpaid tax is assessed each month or part of a month the return is late, up to a maximum of 25 percent. The penalty is based on the amount of tax due, minus any credit the taxpayer may receive and any payment made by the due date. In general, interest on underpayments, including any applicable penalties, accrues on the due date of the amount is owed and continues to accrue until the balance is paid in full. For example, if a taxpayer owing $3,000 on a Form 1040 fails to file a return or request an extension (perhaps thinking they will file once they can pay), they could incur $750 in penalty, plus interest, within five months! Even when the amount of tax due on a taxpayer’s return is not large, but the return is over 60 days late, there is a minimum failure-to-file penalty that is the lesser of $435 or 100 percent of the tax required to be shown on the return.
Taxpayers who know they owe tax should either file the return or request an extension by April 18. Even though filing the return will not address the consequences of owing the tax, timely filing will help avoid late filing penalties. The extension will be granted if the taxpayer completes the form properly, makes a proper estimate of the tax, and files the form by the due date of the return.
Interest rates are determined quarterly and are based on the federal short-term rate plus 3 percent and compounds daily. In addition to interest, the failure-to-pay penalty of one-half of one percent for each month and accrues up to a maximum of 25 percent. The IRS provides a good reference tool that provides calculations of the quarterly interest rate on tax due on its Newsroom Search feature. IRS interest rates may be substantially less than credit card or other bank loan interest rates, which may impact timing of these payments. Taxpayers should avail themselves of the installment agreement or collection option discussed below.
Payment of the amount shown as tax due on the tax return should be made by the filing deadline. Remember, an extension to file is not an extension to pay. A failure-to-pay penalty, plus interest, will be assessed for each month the tax remains unpaid beginning on the original due date of the return. This penalty is assessed even if the taxpayer has a valid extension of time to file. The penalty is generally one-half of one percent per month or part of a month the tax remains unpaid, up to a maximum of 25 percent. However, if an individual taxpayer files a timely tax return (including extensions) and enters into an installment agreement, the failure-to-file penalty will be reduced to one-quarter of one percent per month or part of a month for any month during the approved payment plan.
If the IRS issues a notice of intent to levy, the penalty increases to one percent per month or part of a month after ten days from the date on the notice if the tax remains unpaid.
When both the failure-to-file and failure-to-pay penalties are imposed for the same month, the amount of the failure to pay penalty reduces the amount of the failure-to-file penalty.
Taxpayers who live or have a business in a federally declared disaster area may be eligible for the postponement of certain tax deadlines, including filing and payment deadlines. Please review the list of recent tax relief provided by the IRS in disaster situations. See also my recent blog concerning relief for taxpayers affected by disasters in parts of Alabama, California, and Georgia. This blog has an important discussion about a mismatch between the three-year lookback rule of IRC § 6511(b)(2)(A) and the date payments were made (or deemed made) for taxpayers filing a refund claim after taking advantage of postponed filing deadlines.
There are several options for requesting penalty relief. The taxpayer may qualify for penalty relief if they can show the failure to timely file the required return or pay taxes due on time was due to reasonable cause and not willful neglect. To establish reasonable cause, the taxpayers must show that they acted with ordinary business care and prudence but were unable to file the return within the prescribed time or were unable to pay the tax by the due date or that payment on the due date would cause an undue hardship. The reasonable cause is determined case by case considering all the facts and circumstances. Please consult IRS.gov for types of penalty relief.
First-Time Abate (FTA) may be an option to consider when the taxpayer can show filing compliance, payment compliance, and a clean penalty history. Taxpayers must show they did not have to file a return or have no penalties assessed against them in the prior three years (or any penalty was removed for an acceptable reason other than FTA, for example, due to reasonable cause); have timely filed all required returns (or filed a valid extension); and have paid or have a valid payment plan to pay all taxes due for years other than the year for which the relief is requested. Supporting documentation is not required if a taxpayer meets FTA criteria. However, taxpayers must request penalty relief to be considered for FTA. However, I have been in discussions with the IRS to apply FTA relief to taxpayer accounts systemically, when appropriate.
If taxpayers do not pay their taxes by the due date, they risk not only being subjected to penalties but also to the IRS’s significant collection powers.
To provide relief to taxpayers during the COVID-19 crises, on March 25, 2020, the IRS took steps to suspend some compliance actions and later expanded this relief in February 2022. These actions included the suspension of some collection notices, such as lien and levy notices. As the IRS returns to normal operations, collection activities will resume. Before taxpayers receive any collection notices, they will first receive a CP-14 balance due notice. These balance due notices relating to the current filing season will be sent out beginning in May. The absolute worst thing taxpayers can do would be to ignore these balance due notices or any other IRS letters and notices. If taxpayers receive a balance due notice and cannot immediately pay the full amount, there are several collection alternatives they can take advantage of, including:
The IRS has information about the Collection Process online and in Publication 594. The best thing taxpayers can do is arm themselves with the information before their tax return is due and familiarize themselves with the Taxpayer Bill of Rights in Publication 1 and Collection Appeal Rights in Publication 1660.
The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.