Penalty for Late Payment of Income Taxes

Back in high school, when you turned in a term paper late, your grade was probably reduced by your tardiness. The Internal Revenue Service operates on the same principle.

H&R Block employee assists with taxes.
Tim Boyle/Getty Images
An H&R Block employee in Des Plaines, Ill., helps Senada Imsirovic (left) complete her tax return on April 13, 2006.

Even if you only need an extra week to file your return, use Form 4868 to file for an extension. A week may not seem like much, but you're better off avoiding the late penalty.

As mentioned, filing an extension does not suspend interest from accruing on your tax liability, nor does it necessarily prevent penalties for not paying by the due date.

The IRS assesses a late-payment penalty if you do not pay 90 percent or more of your unpaid tax by April 15, even if you file Form 4868. For example, let's say you owe $5,000 in taxes:

$5,000 x 0.90 = $4,500

If you don't pay at least $4,500 when you file Form 4868, the IRS will assess a late-payment penalty. The penalty is 0.5 percent of the amount you owe per month. This penalty continues until you have paid the maximum 25 percent penalty. Using the example above, the late-payment penalty would be:

$5,000 x 0.005 = $25 per month up to 25 percent, or $1,250

So the sooner you pay off the unpaid taxes, the less you will pay in penalties.

If you file your tax return on time and apply for an installment agreement, the IRS reduces your late-payment penalty to 0.25 percent per month.

$5,000 x 0.0025 = $12.50 per month.

If you do not apply for the filing extension, the late-filing payment fee is 4.5 percent of the unpaid tax per month up to five months.

$5,000 x 0.045 = $225 per month

Offer in Compromise
If there's no way you can pay your taxes, you might be eligible to make an offer in compromise, which is simply "your best offer" -- you pay an agreed-upon chunk of what you owe. The IRS will accept an offer in compromise if it doubts it will ever be able to collect your full tax liability, or if collecting the full amount would "create an economic hardship" like putting you on the streets [source: IRS].

In addition to late-payment penalties, any tax you owe after April 15 will accrue interest. Remember, a filing extension is not a payment extension. This interest, which is compounded daily, will continue to accrue for as long as you owe tax. As with late-payment penalties, the sooner you pay off the tax, the less interest you'll pay.

The interest rate on unpaid tax is "the federal short-term rate plus 3 percent." As of the second quarter of 2008, the interest rate on unpaid tax (for individual taxpayers, not businesses) is 6 percent [source: IRS].

Let's take the above example again, in which you owe the IRS $5,000. We'll calculate the interest for one month.

­Interest

$5,000 x .06 = $300

Penalty + Interest

$25 + $300 = $325

So you would owe $325 for every month you don't pay on top of the $5,000 in taxes you already owe the IRS. Now, this simple example doesn't take into account any payments you make on your tax during the year, but it should give you an idea of how large tax debt can grow and grow. And making payments on your unpaid taxes is what an installment agreement is all about. Check it out on the next page.