Can’t Pay Your Taxes, What’s Next?

As the October extension deadline approaches to file individual tax returns many Americans find themselves face-to-face with an uncomfortable reality: owing taxes they are unable to pay.  Some did not have enough taxes withheld from their paychecks.  Others didn’t realize how much of their social security would be taxable.  Many are business owners who have a “paper-profit” but are stuck in the cash-poor mire of a reboundless recession. 

Regardless of the reason they owe back taxes, all face a common dilemma that includes the prospect of interest, penalties, and the vast collective resources of the federal government.  Today I’ll discuss the interest and penalties the IRS imposes on unpaid taxes and why it is important to file your tax return – especially when you owe a tax liability.  I will also share a few circumstances under which the IRS may remove assessed penalties. 

Interest: The IRS adds interest to past-due balances on a daily basis.  The interest rate used is determined every three months and is benchmarked by adding 3% to the federal short-term interest rate.  Due to an unusually low federal short-term rate, the IRS interest rate applied to underpayment of taxes is currently 3%.  It has remained at 3% since October of 2011.

Late-Payment Penalty:  The IRS also imposes two penalties on past due individual return balances.  The first is the late-payment penalty.  The late-payment penalty is one-half of one percent (0.5%) of the outstanding tax balance and is assessed each month or part of a month taxes remain unpaid up to 25% of the unpaid tax.  The late-payment penalty increases to one percent (1%) if taxes remain unpaid ten days after a Notice of Intent to Levy (a notice that the IRS plans to take property to satisfy a tax obligation) is filed.  The penalty is reduced to one quarter of one percent (0.25%) if the original return was filed by the due date and an installment agreement has been established.

Late-Filing Penalty: The late-filing penalty is equal to five percent (5%) of any unpaid tax.  It is assessed each month or part of a month a return is not filed passed the due date up to 25% of the unpaid balance (five months).  If a return is over 60 days late the minimum penalty is $135 or the tax due, whichever is smaller. 

Importance of Filing: There is a tendency for those who owe taxes to make the very costly mistake of not filing their returns by their due date.  Simply filing their return, even if it shows a tax due, will avoid the late-filing penalty and save 25%. 

At current IRS interest rates, simply filing the return before the deadline and requesting a payment plan for the balance due will be the same as taking out a loan with an annual interest rate of approximately 6%.  On the other hand, filing over five months late and not requesting a payment plan will cost 9% annually plus the 25% late-filing penalty to any balance due.

Removing Interest and Penalties: There are a number of circumstances under which interest and penalty may be removed by the IRS.  Unfortunately, however, it is the responsibility of the taxpayer to petition the IRS for their removal. 

Interest is the most difficult assessment to have removed and is generally only abated as the result of: 1) An IRS administrative delay, 2) It was assessed on a balance due caused by an erroneous, IRS generated refund, or 3) It was assessed during a period in which an extension was allowed due to a region being a presidentially declared disaster area. 

The IRS may remove late-filing and late-payment penalties if the failure to file or pay was due to “reasonable cause,” not intentional neglect.  What is deemed “reasonable cause,” however is quite limited and can include: 1) Destruction of the taxpayer’s home or business, 2) The taxpayer being absent from their “tax home” for reasons beyond their control, or 3) The death or illness of the taxpayer or an immediate family member. 

In this article we have discussed the interest and penalties imposed on delinquent individual taxes and the importance of filing your income tax return by its due date.  If you should have any questions or need assistance preparing your return or solving your own tax “problems” please feel free to contact our office to speak with a tax professional. 

Brett Hersh's avatar
  • Author: Brett Hersh
  • Bio: Brett Hersh, EA, MBA, is the owner of HBS TAX & Small Business Experts. He is an Enrolled Agent (EA) with the IRS and licensed by the US Treasury Department to prepare all tax returns and represent taxpayers before the IRS for audits, collections and appeals. He is also Dave Ramsey’s ELP for Tax and Accounting, a continuing education instructor for tax professionals through Lorman Education, and a local speaker/presenter on the topics of tax and business growth. He can be reached at (304) 267-2594.