For fiscal year 2020, the Internal Revenue Service (IRS) paid $3.03 billion in interest on delayed refunds to taxpayers because it failed to get the payments to them on time. The IRS gave some justifications for the delay, namely, a backlog in work, inundated phone lines and staffing issues due to the coronavirus.
Not unlike the IRS, a taxpayer must pay penalties and interest for delays or non-compliance with tax law. The problem for the taxpayer, of course, is that the penalties and interest assessed by the IRS are not deductible.
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Tax Filing Deadline Extension
As a taxpayer, you can request an extension of your tax filing deadline using Form 4868. If the IRS approves your request, you have up to an additional six months to file your U.S. individual income tax return.
Even if the IRS approves your request, however, the deadline for paying your taxes remains the same. If you secure an extension, you'll have until October 15 (or next business day if on holiday/weekend) to file your return, but your payment is due April 15 (or next business day if on holiday/weekend). If you are confident that you will owe taxes on April 15, estimate the amount, deduct any tax that you've paid and send the IRS a check for that amount.
Basics of IRS Penalties
When a taxpayer violates federal, state or local tax laws, the taxing entity assesses penalties. Violations include the failure to file a return or pay amounts due, misreporting income, dishonored checks or claiming false deductions or tax credits.
The exact penalty a taxpayer will pay will vary depending on the violation she commits. Regardless, according to the IRS, all penalties serve as a disincentive to commit tax fraud or to fail to file a return and pay the amount due in a prompt and accurate way. Once the IRS audits a tax return and assesses penalties and interest on unpaid amounts, it sends a notice to the taxpayer.
The IRS failure-to-pay penalty is assessed on taxes that remain unpaid after the due date. The penalty is assessed each month or each partial month until the issue is resolved.
Often, the failure to pay relates to dishonored checks or the failure to file a return by its due date, the failure to pay taxes owed in their entirety by the due date or the failure to pay the correct amount of estimated taxes.
Installment Agreement and Penalties
In some cases, the IRS allows the taxpayer to make installment payments until she pays her outstanding balance in full. Once the taxpayer enters into an installment agreement, the failure-to-pay penalty is no longer assessed.
Amount of Penalties
The type of penalty imposed influences the dollar value of the penalty the taxpayer must pay. For instance, a taxpayer is assessed a 5 percent penalty if she doesn't file a return on time. This penalty is assessed each month for five months following the tax filing due date, which is typically April 15.
According to the IRS website, if both the failure-to-file and failure-to-pay penalties are due, the combined penalty is a total of 5 percent, an amount which consists of a 4.5 percent late filing fee and a 0.05 percent late payment fee. The fees, which are assessed each month that the return is late, are a maximum of 25 percent of the amount due.
IRS Assessment of Interest
Typically, the IRS assesses penalties and interest on the balance a taxpayer owes. The interest, in particular, may accrue until the taxpayer pays the entire amount due or until she enters into a payment plan. As with penalties, the interest is not tax-deductible.
Read more: Penalties for a Mistake on Federal Taxes
No Penalty or Interest Write-Off
Generally, the IRS does not allow a taxpayer to deduct the penalties the agency assesses due to the taxpayer's failure to file a return or pay amounts due, accurately report income or claim valid deductions or tax credits. It might be possible, however, for the IRS to grant a taxpayer relief due to extenuating circumstances.
In this case, the IRS may relieve all or some portion of an assessed penalty. Even so, the interest on the tax payment due will accrue until the taxpayer pays the amount she owes in full.
Exceptions to Disallowance Rules Under Section 162(f)
In January 2021, the IRS released the final regulations governing the deductibility of fines and similar penalties paid to governmental entities under tax code Section 162(f). Section 162(f) applies to fines or penalties paid to a government or governmental entity.
According to Bloomberg News, "The deduction disallowance generally applies to any 'fines, penalties, and other amounts' paid or incurred to a governmental entity," if they relate to the violation of law or the investigation into the potential violation of any law. If, however, a deduction is otherwise allowable under the tax code, taxpayers will still be allowed a deduction for legal fees and other expenses paid or incurred in the defense of a prosecution or civil action arising from a violation of the law.