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The deadline for taxpayers to file their 2023 individual tax returns or request an extension is Monday, April 15, 2024. Keep in mind that filing an extension does not extend the date on which your taxes are due, it simply extends the date when your return must be filed.
If you underpaid your taxes or if you fail to make the estimated tax payment due with your request for an extension, you will receive a notice from the IRS requesting additional interest and penalties. These notices can be confusing, as they provide little clarification as to the reason for the increase in your tax bill. Let’s pull back the curtain and explore interest charges and the five types of penalties charged by the IRS.
If you’re in or nearing retirement, be sure to read the bonus content at the end for a big change regarding required minimum distribution (RMD) penalties.
Interest Charges
The IRS charges interest on late or unpaid taxes. Interest is even charged on penalty amounts! The interest charges begin with the original due date of the return (generally April 15th) and compound daily until the IRS receives payment of the tax due. Even with a payment plan in place, interest will accrue.
The interest rate on unpaid Federal tax is determined and posted every three months. It is the federal short-term interest rate plus 3%. Below are interest rates for the current and prior year.
Time Period | Interest Rate |
1/1/24-3/31/24 | 8% |
10/1/23-12/31/23 | 8% |
7/1/23-9/30/23 | 7% |
4/1/23-6/30/23 | 7% |
1/1/23-3/31/23 | 7% |
Types of IRS Penalty Charges
Late Filing Penalties
If you owe tax and don’t file a return or extension on time, IRS regulations state that an additional penalty of 5% of the tax due will be charged to the taxpayer for each month your return is late (maximum of 25%). This penalty is in addition to BOTH the tax owed and the interest on the past due tax.
Failure to Pay Penalty
If you fail to pay your taxes, the IRS will penalize you based on how long your overdue taxes remain unpaid. Even if you file an extension and file your return before October 17th, this penalty will still apply, as your tax payment was due by April 15th.
The penalty will be a percentage of the taxes you didn’t pay or a percentage of the taxes you didn’t report on your return. Each month your taxes remain unpaid generates a 0.5% penalty, so paying your tax bill 2 months late would result in a 1% penalty. The failure to pay penalty has a maximum charge of 25% of your unpaid taxes.
Underpayment of Estimated Tax
The underpayment of estimated tax penalty can apply to individuals, even if they receive a refund. The penalty is issued when the individual fails to pay the estimated amount of tax on their income or fails to pay the estimated tax by the due date.
Income taxes are actually due as income accrues throughout the year. This is why most employees see federal income tax withholding taken from each of their paychecks. For those who work independently (or for W-2 employees with a 1099 side hustle), it’s important to estimate tax liability and make your own quarterly tax payments to the IRS. Don’t forget to factor in any self-employment taxes along with your income taxes. IRS Form 1040-ES can help you determine your estimated taxes. ProTip: Monotelo is a full service tax preparer with specialized staff devoted to both personal and small business taxes.
For most taxpayers that withhold income through their W2, this underpayment of estimated tax penalty does not factor in. However, for self-employed individuals or people with unexpected income, such as a rental property or other asset sale, this can often cause an unpleasant surprise.
Accuracy-Related Penalties
Accuracy-related penalties are charged when taxpayers claim deductions they shouldn’t, or they fail to report all their income. There are two common examples of this:
Negligence or Disregard of the Rules or Regulations Penalty: An individual can receive this penalty if they don’t make a reasonable attempt to follow tax return laws or if they intentionally ignore the tax laws when filing their return.
Substantial Understatement of Income Tax: An individual receives this penalty when the tax shown on their return is understated by 10% or $5,000 depending on which amount is larger.
Accuracy-Related Penalties are assessed at a rate of 20% of the understated tax.
Dishonored Checks
If a check bounces or a bank account lacks sufficient funds to make a tax payment, the taxpayer will be subject to a Dishonored Checks Penalty. If this occurs, the Dishonored Check Penalty is $25 if the payment amount is less than $1,250, or 2% of the payment amount if it is more than $1,250.
Abatement of IRS Penalties and Interest
As a rule of thumb, you may request an abatement of penalty if you show cause. While you can request an abatement of penalties, interest on late tax payments are not as likely to be removed.
Required Minimum Distributions
The rollercoaster of RMD changes may finally be coming to a halt and a change to the way penalties are calculated will bring some relief.
A very brief overview of recent legislation:
SECURE Act (2020) raised the RMD age from 70.5 to 72 This eliminated the pesky half year convention for those new to RMDs.
CARES Act (2020) temporarily paused withdrawal requirements This ushered in a period of confusion as RMDs stopped and eventually restarted.
SECURE 2.0 (2022) raised the RMD age to 73
SECURE 2.0 also reduced the penalty for failure to take the required RMD amount to 25% of the undistributed amount. This is half of the previous penalty of 50%. Under the old rules, a taxpayer with a $10,000 RMD could be penalized $5,000 for failure to make a timely distribution. In contrast, a taxpayer who fails to take their RMD on time in 2024 would owe a penalty of $2,500.
Common life events, like getting married, selling a home, having a baby, paying for education expenses (from daycare to beyond), deciding to work for yourself or pick up a side hustle, or transitioning into retirement, can all have tax implications. At Monotelo, we can do more than file your taxes. We can also help estimate your withholding and discuss strategies for minimizing your tax bill. Don’t let interest and penalties cause you to pay more than you owe in taxes when we can help you plan to avoid them.
This article is a general communication being provided for informational and educational purposes only and is not meant to be taken as tax advice, investment advice or a recommendation for any specific investment product or strategy. The information contained herein does not take your financial situation, investment objective or risk tolerance into consideration. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. Any examples are hypothetical and for illustration purposes only. All investments involve risk and can lose value, the market value and income from investments may fluctuate in amounts greater than the market. All information discussed herein is current only as of the date of publication and is subject to change at any time without notice. Forecasts may not be realized due to a multitude of factors, including but not limited to, changes in economic conditions, corporate profitability, geopolitical conditions, inflation or US tax policy. This material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.
LEGAL, INVESTMENT AND TAX NOTICE. This information is not intended to be and should not be treated as legal, investment, accounting or tax advice.
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