How Does the IRS Calculate Penalties and Interest?
The Internal Revenue Service is well known for its enforcement of stiff penalties and interest for tax liabilities. In fact, some of the first questions I get from prospective clients facing federal tax debt are along the lines of “How much of this bill is penalties and interest” or “Is there any way you can remove the penalties and interest”. The most common penalties imposed by the IRS are (1) failure to file; and (2) failure to pay penalties.
Failure to File Penalties
The Internal Revenue Code sets forth a relatively complex framework for calculating these penalties. Generally speaking, failure to file penalties are 5% of the unpaid tax that was required to be reported on the return. This penalty is charged up to five months. I.R.C. § 6651(a)(1).
Failure to Pay Penalties
Failure to pay penalties are generally 0.5% of the tax owed (0.25% under an installment agreement) that wasn’t paid by the due date (April 15th). This penalty is incurred monthly until the tax is paid or the total penalty reaches 25%. Failure to file penalties are reduced by the amount of failure to pay penalties when both penalties are due at the same time. I.R.C. § 6651(a)(2)
Interest on any unpaid tax is compounded daily and accrues until the balance is paid in full. The interest rate changes quarterly and is the federal short-term rate plus 3 percent. Interest rates for 2017 are illustrated below.
|Oct. 1, 2017 – Dec. 31, 2017||4%|
|Jul. 1, 2017 – Sep. 30, 2017||4%|
|Apr. 1, 2017 – Jun. 30, 2017||4%|
|Jan. 1, 2017 – Mar. 31, 2017||4%|
Can the IRS Remove Penalties and Interest?
The IRS has the ability to remove penalties if the taxpayer can prove reasonable cause for removal. The IRS generally cannot remove or waive interest, although there are a few extremely rare exceptions. See I.R.C. § 6404(e).
How do I Get the IRS to Remove or Waive Penalties?
A taxpayer can generally request a penalty abatement from the IRS by completing IRS form 843 and mailing it either to the address on the last IRS notice received or to the IRS service center where a tax return would ordinarily be sent. In order to qualify for a penalty abatement, a taxpayer must prove that their failure to file or failure to pay was attributable to reasonable cause and not willful neglect. I.R.C. § 6651(a). Reasonable cause examples provided by the IRS include:
- Fire, casualty, natural disaster or other disturbances
- Inability to obtain records
- Death, serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family
- Other reason which establishes that a taxpayer used all ordinary business care and prudence to meet their Federal tax obligations but were nevertheless unable to do so
Some taxpayers may also qualify for a first-time penalty abatement, regardless of whether reasonable cause exists. These abatements can generally be requested by calling the IRS or submitting IRS form 843. The requirements for a first-time penalty abatement are as follows:
- No penalties have been incurred for the 3 tax years prior to the tax year with a penalty
- All currently required returns or extensions have been filed
- Any tax due must be paid or arranged to be paid.
Tyler DeWitt is experienced in civil and criminal tax issues and has represented taxpayers in various IRS and state penalty matters. Request a free tax consultation today.