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Late Payment and Late Filing Penalties

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By Roy Lewis

I have recently received a number of questions about the IRS's imposition of the late payment and/or late filing penalties. I guess some of you filed your returns without the benefit of an extension. Or it could be that you had a balance due on your tax return and did not submit payment in full. Since these two penalties may impact some of us at one time or another, it would be worth our while to review the IRS structure regarding them.

Late Payment Penalty: The failure-to-pay penalty is the "kinder and 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. In effect, there is no future "risk" with respect to this penalty.

Let's look at an example. Don Delinquent files his tax return on April 15th, and his tax return showed that he owed $5,000. Due to some bad planning, Don didn't have the funds to pay his taxes with the filing of his tax return. Don finally made his payment in full on June 4. Don's penalty amounts to 1 1/2% of the balance due. (Remember� the penalty is 1/2% for each month or PART of a month). So, while Don was really less than two full months late, he gets hit for 1/2% for April, May, and part of June. Ouch. Anyway, Don's late payment penalty amounts to 1 1/2% of $5,000 (or $75).

Let's also say that Don is unlucky enough to get audited on this tax return. Uncle Sammy determines that Don's actual balance due should have been $6,000. Don's late payment penalty is NOT increased by the additional $1,000 of tax found during the audit. But on the other hand, if the audit revealed that Don's actual balance due should have been only $2,000, the IRS is required to reduce Don's late payment penalty to 1 1/2% of $2,000 (or $30). This is a penalty reduction of $45. It ain't much, but it's nice to know that if the tax liability is found to be less than the original amount, the penalty will also float downward.

Failure-to-File Penalty: 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.

If the 1/2% failure to pay penalty and the failure to file penalty both apply, the failure to file penalty drops to 4 1/2% 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 1/2%). Thus, the combined penalties can reach a total of 47 1/2% over time. Wow.

You now can see how the money adds up quickly when you decide to "ignore" filing your tax return. Many taxpayers fall into this trap because they have a balance due, and just don't have the money to pay the tax. These numbers should hammer home the point that you want to always file your tax return on a timely basis, even if you can't pay your tax at the time the return is due. Dodging the failure-to-file penalty can save you a ton of penalty dollars.

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.)

Let's take a look at Don again. Let's say that Don decided not to file his return on April 15 because he knew that he had a balance due that he just couldn't pay. Don files his return on June 4 and pays the full $5,000 balance due at that time. He can expect to receive a notice from Uncle Sam charging him an additional $750 in late payment/late filing penalties ($5,000 X 15%� 5% for each of three months, or part of a month).

And it gets worse. If Don is audited and it is determined that the actual tax liability is 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. Double ouch.

It's very easy to see that Don could have saved himself $675 in penalty fees just by filing the stinkin' tax forms on April 15� even if he couldn't pay the tax in full at that time.

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 $100. Even here, however, if you owe no taxes, there is no penalty. And, it should also be pointed out that in particularly abusive situations involving a fraudulent failure to file, the late filing penalty can jump to 15% a month, with a 75% maximum.

Reasonable Cause: Both penalties may be excused by the IRS if your lateness is due to "reasonable cause." Reasonable cause can be a tricky subject, and we'll talk more about it next week.

This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.