A sign identifies the Internal Revenue Service (IRS) building in Washington, D.C., U.S., on Monday, April 16, 2012. The deadline for individuals to file their 2011 tax returns is April 17. Photographer: Andrew Harrer/Bloomberg via Getty Images
Expect another frustrating tax season. Here's why
02:35 - Source: CNN

Unless you enjoy throwing money away, you’ll want to do all you can to avoid being hit with tax penalties and interest if you end up owing money to the IRS on your 2021 tax return.

Even a relatively small balance owed can balloon quickly. Say you owe the IRS another $1,000, but don’t file your return or pay the money for six months past the original due date. Your bill could grow to at least $1,615.

Here’s a breakdown of how penalties and interest accrue and how to protect yourself from that happening.

Missing the filing deadline

You could be subject to a failure-to-file penalty if you still owe money to the IRS for tax year 2021 and do not file your federal tax return by your official filing deadline. That is April 18 for most people, April 19 for residents of Maine and Massachusetts, and a month or more later for people living in federally declared disaster areas, or US taxpayers living outside of the country on April 18.

The failure-to-file penalty is steep: 5% of the unpaid tax you owe for each month or part of a month that your return is late. That means if you’re supposed to file on April 18 but don’t do so until May 5, you must pay 10% of your balance for being two months late, said Larry Gray, a CPA and managing partner of AGCCPA in Missouri.

The maximum penalty you pay is capped at 25% of your outstanding balance. That is helpful in instances when you owe large sums like, say, $10,000. In that case, you wouldn’t owe more than $2,500 after five months.

However, with smaller balances, you’re likely to pay more than 25% because you’ll be hit with a minimum penalty that applies when you’re more than 60 days late. That minimum is set at $435 or 100% of your tax due, whichever is less.

So on a $1,000 balance, you’d owe $435 at the six-month mark just for not filing on time.

(If you’re due a refund, you won’t be hit with a fee.)

The good news: It’s ridiculously easy to avoid the failure-to-file penalty. If you can’t submit a complete and accurate return by April 18, stop what you’re doing right now and request an automatic six-month extension by filling out Form 4868. That way you’ll have until October 17 to file your return without a late filing penalty.

The late payment penalty

Even if you file on time or file for an extension and avoid the failure-to-file penalty, you could be subject to a late payment penalty unless you pay off your balance in full by the original filing date.

If you don’t, you will have to pay 0.5% on your outstanding balance for every month or part of a month that you’re late. The longer you wait to pay, the greater the penalty, although the maximum penalty here is also capped at 25% of your outstanding balance.

So if you owe $1,000 and don’t pay it for six months, you could owe another $30 ($5 a month for six months). If you delay payment longer, you would cap out at a maximum of $250.

You can minimize the penalty in a couple of ways. Pay at least part of what you owe by the original filing due date. Or, if you file your return and are put on an approved payment plan with the IRS, the 0.5% per month penalty gets reduced to 0.25% of your outstanding balance, Gray noted.

On the other hand, he said, your penalty rate could go up to 1% a month if you’ve been very delinquent and do not repay what’s owed within 10 days of getting a notice CP504 from the IRS. That notice informs you that if you don’t pay what you owe, the agency will levy your bank account, wages or state refund to settle your account.

If you have a good reason for not paying on time, you can make your case to the IRS by attaching a statement to your return whenever you do file it. If the IRS accepts your explanation, it may waive the penalty. At a minimum, you need to show that your failure to pay is not the result of “willful neglect.” As the IRS puts it, “making a good faith payment as soon as you can may help to establish that your initial failure to pay timely was due to reasonable cause and not willful neglect.”

Keep in mind that if you don’t file your taxes or pay what you owe, you’ll be hit with both the failure-to-file fee and the late payment penalty. The exception here is if you live in a federally declared disaster area in which case the IRS typically grants both an extension to file and to make tax payments.

Don’t forget, there’s interest too

Failure to file and late payment penalties are hardly the only levers the IRS can pull. You also could get hit with “accuracy-related” penalties if, for instance, you seriously understate the tax you owe, which can result from underreporting your income. Or if you willfully ignore tax rules.

Whatever you get hit with, until you pay your tax bill in full, interest will continue to accrue on both your unpaid tax balance and even on the subsequent penalties that get added to your tab if they go unpaid. The IRS adjusts its interest rates quarterly – and sets them at the federal funds rate, plus 3%.

Of course, the best way to avoid these expensive headaches is to file on time and pay in full. But if you’re coming up short on the money front, the IRS offers this advice: “Often, you can borrow the funds necessary to pay your tax at a lower effective rate than the combined IRS interest and penalty rate.”