IRS Raises Interest Rate On Underpayments

If you estimate your taxes and estimate low, or pay a lower of higher amount than you are required to pay, you'll now pay more in interest rates.

The Internal Revenue Service (IRS) has announced that interest rates for the calendar quarter beginning April 1, 2011, will increase by one percentage point.  The rates will be:

• four (4) percent for overpayments (three (3) percent in the case of a corporation);
• four (4) percent for underpayments;
• six (6) percent for large corporate underpayments; and
• one and one-half (1.5) percent for the portion of a corporate overpayment exceeding $10,000.

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis.  For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus three percentage points. (Read consumer complaints about tax preparation companies).

Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus three percentage points and the overpayment rate is the federal short-term rate plus two percentage points.  The rate for large corporate underpayments is the federal short-term rate plus three percentage points.

The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.  Additionally, the rate for determining the addition to tax for failure to pay estimated tax for the first 15 days in April 2011 is the four percent rate that applied to underpayments of tax during the first calendar quarter in 2011.

The interest rates are computed from the federal short-term rate during January 2011 to take effect February 1, 2011, based on daily compounding.

In addition to paying interest, you usually will face a financial penalty for underpaying, or not paying your taxes on file. If fraud is involved, the penalties are more than financial and involve criminal prosecution. Penalties are generally payable upon notice and demand and are generally assessed, collected and paid in the same manner as taxes.

Estimated Tax-Related Penalties

Employees have taxes withheld from their paychecks by their employer. When you have income that is not subject to withholding you may have to make estimated tax payments during the year. 

This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. You also may have to pay estimated tax if the amount being withheld from your salary, pension, or other income is not enough to pay your tax liability.

Estimated tax payments are used to pay income tax and self-employment tax, as well as other taxes and amounts reported on your tax return. If you do not pay enough through withholding or estimated tax payments, you may have to pay a penalty. If you do not pay enough by the due date of each payment period you may be charged a penalty even if you are due a refund when you file your tax return.

Penalties for filing or paying taxes late

The most common penalties are for filing late or paying taxes late. If you do not file your return by the due date (including extensions), you may have to pay a failure-to-file penalty. The penalty is usually five percent for each month or part of a month that a return is late --but not more than 25 percent. The penalty is based on the tax not paid by the due date (without regard to extensions).

If you file your return more than 60 days after the due date, the minimum penalty is $100 or, if less, 100 percent of the tax on your return.

You will have to pay a failure-to-pay penalty of one-half of one percent (0.5 percent) of your unpaid taxes for each month, or part of a month, after the due date that the tax is not paid. This penalty does not apply during the automatic six-month extension of time to file period if you paid at least 90 percent of your actual tax liability on or before the original due date of your return and pay the balance when you file the return.

The failure-to-pay penalty rate increases to a full one percent per month for any tax that remains unpaid the day after a demand for immediate payment is issued, or 10 days after notice of intent to levy certain assets is issued.

For taxpayers who filed on time, the failure-to-pay penalty rate is reduced to one-quarter of one percent (0.25 percent) per month during any month in which the taxpayer has a valid installment agreement in force.

For any month both the penalty for filing late and the penalty for paying late apply, the penalty for filing late is reduced by the penalty for paying late for that month, unless the minimum penalty for filing late is charged.

Accuracy related penalties

The two most common accuracy related penalties are the "substantial understatement" penalty and the "negligence or disregard of the rules or regulations" penalty. These penalties are calculated as a flat 20 percent of the net understatement of tax.

Understatement of tax means the tax shown on your return is less than the correct tax. The understatement is substantial if it is more than the larger of 10 percent of the correct tax or $5,000 for individuals. For corporations, the understatement is considered substantial if the tax shown on your return exceeds the lesser of 10 percent (or if greater, $10,000) or $10,000,000.

Penalty for negligence and disregard of the rules and regulations

"Negligence" includes (but is not limited to) any failure to:

• make a reasonable attempt to comply with the internal revenue laws
• exercise ordinary and reasonable care in preparation of a tax return or
• keep adequate books and records or to substantiate items properly

This penalty may be asserted if you carelessly, recklessly or intentionally disregard IRS rules and regulations -- by taking a position on your return with little or no effort to determine whether the position is correct or knowingly taking a position that is incorrect. You will not have to pay a negligence penalty if there was a reasonable cause for a position you took and you acted in good faith.

Civil fraud penalty

If there is any underpayment of tax on your return due to fraud, a penalty of 75 percent of the underpayment due to fraud will be added to your tax. The fraud penalty on a joint return does not apply to a spouse unless some part of the underpayment is due to the fraud of that spouse. Negligence or ignorance of the law does not constitute fraud.

Typically, IRS examiners who find strong evidence of fraud will refer the case to the Internal Revenue Service Criminal Investigation Division for possible criminal prosecution. Keep in mind that both civil sanctions and criminal prosecution may be imposed.

Frivolous tax return penalty

You may have to pay a penalty of $5,000 if you file a frivolous tax return or other frivolous submissions. If you jointly file a frivolous tax return with your spouse, both you and your spouse each may have to pay a penalty of $5,000. A frivolous tax return is one that does not include enough information to figure the correct tax or that contains information clearly showing that the tax you reported is substantially incorrect.

You will have to pay the penalty if you filed this kind of return or submission based on a frivolous position or a desire to delay or interfere with the administration of federal tax laws. This includes altering or striking out the preprinted language above the space provided for your signature, This penalty is added to any other penalty provided by law.

Penalty for bounced checks

If you write a check to pay your taxes, make sure there are funds available to cover it. This is a check you don't want to bounce. If the check bounces, the IRS may impose a penalty. The penalty is either two percent of the amount of the check unless the check is under $1,250, in which case the penalty is the amount of the check or $25, whichever is less.

"The bottom line is that you must report all your income, file your return and pay your tax by the due date to avoid interest and penalty charges," the IRS says.