How Does the IRS Calculate Penalties and Interest?

IRS Penalties and Interest

The IRS charges penalties and interest for taxpayers who don’t meet their tax obligations and owe a penalty. These penalties and interest are meant to encourage people to follow tax laws and pay their taxes on time. 

To prevent incurring more fees and interest over time, it's important to understand these costs and fulfill tax obligations on time.

How Does the IRS Calculate Penalties and Interest?

The law tells us to determine the IRS interest rates quarterly. The interest is compounded daily except for late or underpaid estimated taxes for individuals or corporations. The interest and penalties are calculated as follows:

INTEREST RATES:

• The underpayment interest rate is 120% if the return was due before January 1, 1990.
• Corporations with underpayments over $100,000 are charged the underpayment interest rate plus 2%.
• These interests are charged until you owe the amount completely.

LATE FILING PENALTY:

• The late filing penalty is 4.5% for a month, and the 0.5% a month penalty for late payment is also applied.
• The penalty is applied to the amount shown as due on the return for any month the return is filed after the due date, up to a maximum of 5 months.
• If the tax return isn't filed within 60 days of the due date, the minimum penalty is $100 or 100% of the tax due, whichever is less.

LATE PAYMENT PENALTY:

• The penalty is 0.5% (0.25% for months covered by an installment agreement) of the tax due for every single month or part of the month your payment is late.
• If you get a notice of intent to levy and still the tax isn't paid, the penalty increases by 1% every month.
• The late filing penalty cannot exceed 25% of the total tax due.

DEPOSIT PENALTY:

• Depending on how late the deposit is, the penalty rates vary from 2% to 15% for employment, excise, and railroad retirement tax.

LATE FILING PENALTY FOR EXEMPT ORGANIZATIONS:

• The penalty is  $20 a day if gross annual receipts are equal to or less than $1 million, and it will not be more than $10,000 or 5% of gross annual receipts, whichever is less.
• If your gross annual receipts exceed $1 million, it is $100 a day for every day your return is late. The penalty will not be more than $50,000.
• For all other forms, the penalty is $10 a day, and will not be more than $5,000.

How Can Penalty and Interest be Removed?

The penalty and interest can be removed only in the following cases:

Penalty Reduction Based on Reasonable Cause:

• To request a penalty reduction, a statement fully explaining the facts must be sent, signed under penalty of perjury by either the taxpayer or their representative.
• In some cases, full payment of the tax may be required before the late payment penalty can be removed or reduced.

Eligibility for Penalty Removal:

• The penalty, but not interest, will be removed if specific criteria are met, like 
• If the person requests advice from the IRS.
• By providing complete and accurate information.
• By following the advice provided by the IRS.
• If you receive a penalty for following that advice.

• To qualify for penalty removal, complete Form 843 with the required documents and send it to the IRS Service Center.

Removal of Interest for Erroneous Refunds:

• The interest will be removed up to the date the IRS requests repayment of an erroneous refund if 
• The taxpayer did not cause the erroneous refund.
• The refund is not more than $50000.

• The IRS may, depending on the circumstances of each case, remove or reduce interest on other incorrect refunds or errors caused by an IRS ministerial act.
• If you claimed interest as a deduction on your tax return before but then the IRS reduced it, you need to include that reduction as income on your tax return for the year.

What are the Quarterly Interest Rates for 2024?

What are the Types of Penalties in IRS?