If you are like most Americans, you may get a little creative in your efforts to reduce your tax obligations and maximize the percentage of your annual income that stays in your accounts. Unfortunately, if you underpay your taxes because you get a little too aggressive with your attempt to avoid taxes, you may receive a notice of deficiency from the IRS that indicates you owe them a substantial amount of money.
The underpayment of your taxes is a serious issue not just because you could eventually become responsible for the amount you didn’t pay but also because the IRS will seek substantial financial penalties and interest from you as part of the process of enforcing tax code.
What interest rate can the IRS charge you?
The IRS charges a specific, fixed interest rate on underpaid or past due taxes. Everyone pays the same interest rate, and the IRS establishes the current rate quarterly. Generally speaking, the interest rate people will pay is the federal short-term lending rate plus and additional 3%.
The interest on individual tax balances compounds daily, which means you pay interest on the full amount plus the interest accrued each day. That means the total balance will grow more quickly than it would on a balance with weekly or monthly compounding interest.
What penalties will the IRS assess against unpaid taxes?
There are separate rules involved for unpaid taxes related to an unfiled tax return versus an underpayment of taxes is on a return you did file. However, the IRS generally uses the same maximum penalty charge of 25% in both scenarios.
If you failed to pay taxes owed on a return you filed, you will incur a late payment penalty of one-half of a percent for each month you delay your payment. For those who don’t file their taxes, the penalty starts at five percent of the taxes owed for each month you’re late.
Those amounts plus interest can quickly turn a manageable amount of tax debt into an insurmountable financial obstacle. Avoiding these charges may require careful compliance with tax law or efforts to push back against underpayment claims as soon as you receive a letter advising you of a deficiency. The sooner you take action and get advice, the less you’ll have to pay in interest and penalties.