10 Ways IRS Tax Debt Can Increase When You’re Not On Top of Taxes

10 Ways IRS Tax Debt Can Increase When You’re Not On Top of Taxes

1. Don’t File a Tax Return on Time or IRS Files Substitute Return

The IRS assesses a 5% Failure to File penalty (FTF) for taxpayers who fail to file a tax return by the April deadline or October extension. How much the penalty amount increases over time depends on total taxes owed and how late a return is.

FTF penalties can be as much as 25% of unpaid taxes. For returns filed more than 60 days after the due date (original deadline or extension), the penalty will be the lesser of the FTF minimum ($485 for 2024 taxes) or 100% of taxes owed.

In addition to a Failure to File penalty, not filing a return can add to your tax liability if the IRS files a substitute return, or SFR, on your behalf. In this case, the IRS won’t give you credits, deductions, or exemptions you may otherwise qualify for when you file yourself.

2. Don’t Pay Taxes On Time, Setup an IRS Installment Agreement, or Submit an Offer in Compromise

When taxpayers don’t pay taxes they owe by the April deadline, the IRS issues a Failure to Pay penalty (FTP) that is usually between 0.5% and 1% of unpaid taxes.

For example, if you owe $1,000 to the IRS for this year’s return and do not pay that amount in full by April, the IRS will add $5-$10 each month to your tax debt.

FTP penalties are separate from Failure to File and additional interest charges are added to your tax debt until you pay if off.

Taxpayers can avoid some penalties, interest, and other IRS fees for tax debt by setting up an IRS payment plan or submitting an Offer in Compromise (OIC). Payment plans allow you to make affordable monthly payments on unpaid taxes, and an OIC allows you to “offer” a settlement amount to the IRS that’s less than what you owe.

Bottom line, not paying any taxes to the IRS will cost you more in penalties and interest than if you arrange to make partial tax payments each month.

3. Don’t Pay Estimated Taxes on Time

Since income from self-employment, being a freelancer or contractor, capital gains, and dividends don’t have taxes withheld when paid.

Individuals with this income must make quarterly tax payments, called estimated taxes, to avoid owing a substantial amount of taxes at the end of the year.

Failing to make an estimated tax payment by the deadline may result in the IRS issuing an underpayment of tax penalty.

Estimated tax penalties are calculated using an individual’s latest tax return, the amount of estimated taxes that weren’t paid, and quarterly IRS interest rates for underpayments. Keep in mind that the IRS also charges interest on past-due underpayments.

4. Pay Taxes with Bad Check or Rejected Electronic Payment

The IRS charges a 2% “dishonored check” penalty when a check or electronic tax payment fails to clear a taxpayer’s bank. For checks or payments under $1,250, a penalty of $25 or the check amount (whichever is lower) applies.

For example, if someone mails a $500 check payment to the IRS, and the check bounces, the IRS will add $25 to that individual’s tax balance.

Letter 608C is mailed to taxpayers when a payment does not go through. It’s important to note that when a check bounces or electronic payment is rejected, the IRS will not make a second attempt to get the money from your bank. You will have to submit another payment.

5. Allow Interest to Accrue on Unpaid Taxes and Penalties

Interest on unpaid taxes is calculated based on the federal short-term interest rate plus 3%. The current IRS interest rate for individual underpayments is 8%. IRS interest rates can go up or down every quarter: https://irs.gov/payments/quarterly-interest-rates.

As we mentioned earlier, the best way to minimize interest on unpaid taxes and penalties is to enter into an installment agreement or Offer in Compromise with the IRS.

6. Make Math Errors On Your Tax Return

Most math errors caught by the IRS are simple and they’ll adjust your return for you. In some cases, however, these errors mean a smaller refund or even a balance due.

You’ll receive a CP11 notice from the IRS when they correct a math error on your return and you now owe taxes. Although the IRS doesn’t have a specific math error penalty, there’s a cost to having a balance due, especially interest charges on unpaid taxes.

7. Claim Deductions or Credits You Don’t Qualify For or Don’t Report All Income

When you claim credits and deductions that you shouldn’t, the IRS will charge you a 20% “accuracy-related” penalty.

As an example, if you understate taxes owed by $1,000, you’ll pay a $200 penalty on top of the $1,000. Accuracy-related penalties can also be assessed for “substantial understatement” of income. Substantial is considered the greater of $5,000 or 10% of taxes that should have been reported on your return.

Just like with other tax penalties, the IRS also charges interest on accuracy-related penalties.

8. Claim Erroneous Refund or Credit

The IRS erroneous refund or credit penalty applies only to claims for refunds or credits greater than what the taxpayer is eligible to receive.

It is also issued to people who claim a refund or credit when they don’t qualify. Refund or credit penalties are 20% of the erroneous amount claimed on a tax return.

For example, if someone claims a $2,000 tax refund when they are only entitled to $500, the IRS assesses a 20% penalty on the additional $1,500.

9. Don’t File an Information Return

An information return penalty pertains to small and large businesses that do not file correct information returns on time or fail to provide correct payee statements.

Information return penalties are $60 when returns are up to 30 days late. After 30 days, penalties top out at $310. If the IRS thinks a business intentionally ignores its request for information returns, the information return penalty jumps to $630.

10. Don’t Pay Employment Taxes on Time or the Correct Amount

Employers who do not make their tax deposits on time, deposit the wrong amount, or use a wrong deposit method may receive an IRS failure to deposit penalty letter in the mail.

The IRS expects employers to complete tax deposits consisting of Medicare, Social Security, and federal income tax on a semi-weekly or monthly schedule. The penalty amount is between 2% and 15% of employment taxes not deposited on time or in the wrong amount.

Know that individuals who are business owners or corporate officers can be personally liable for employment taxes that weren’t paid to the IRS.

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