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.
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 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.
Don’t forget, there’s interest too
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.”