Issue: Does Filing and Extension Cost Penalties & Interest?
Question: I am so confused. This is the first time I have not filed my personal income tax returns on time.
Knowing that I was not going to be able to meet the deadline date, I filed an extension for my return. Then in June I received the last bit of information and was able to complete the return. I mailed the return well before the extension deadline and included a check for the amount of tax due.
Now I have received a notice from the IRS that I owe additional penalties and interest. Why would I be liable for penalties and interest if I filed the extension timely and filed the return before the deadline and paid the taxes due? And what is an underpayment of estimated tax penalty?
Answer: Good questions. First you must understand that the extension you filed was an extension of time to file the tax return, it was NOT an extension of time to pay the taxes due. So, had you been able to file and have a refund you would not have had the late payment penalty. Since you ended up with an amount due you were charged a penalty of ½% per month on the balance of tax due for the time between April 15th and the date the Service received your payment.
In addition to the late payment penalty the Service also billed you for interest on the unpaid taxes from April 15th to the date the payment was received by the Service at the prevailing government interest rate which is about 2% per annum. These charges are set by statute and are very difficult to get abated. Your best option is to pay the amount billed.
Now to the underpayment of estimated tax penalty. It would seem reasonable to presume that you should not be subject to this penalty since you do not make estimated tax payments, you only have wage withholding. Unfortunately that is not how the Service sees the issue. You are required to pre-pay your current years income taxes either by wage withholding, withholding on other incomes, or by making estimated tax payments quarterly. From their point of view you could have increased the amount of your withholding if you were going to owe tax or you could have paid one or more estimated payments.
The safe harbor rule (the basic required amount to be prepaid to avoid the penalty) is, under normal circumstances, 100% of the tax paid the proceeding tax year or 90% of the current year’s tax. So if you had some event during the year that was going to result in additional taxable income you should have insured that you had paid in at least the amount of the prior year’s tax. The safe harbor rule is modified if your adjusted gross income for the current year is more than $150,000 ($75,000 for a single individual) then the required prepayment is 110% of the prior year’s tax.