When my grandmother was with us, I took care of her finances including filing her tax return every year. Her return was very simple, and I usually finished it well ahead of the April 15th deadline. One year, I completed it in early March and determined she owed about $100 to the IRS. I told her she could pay it electronically through the tax software I was using at the time.
The software was designed to deduct the payment from her checking account automatically on April 15th. Tax Day came, I logged in to verify the payment and noticed it had not been made. Something was wrong with the software. I called my grandma and told her she would have to put a check in the mail that day so it would be postmarked on April 15th, making the payment on-time as far as the IRS is concerned.
My grandma was a kind woman and generally calm except for when she was yelling at the Bengals on TV. And yet, when I explained the time-sensitivity of mailing her tax payment, she had, let’s call it, a strong reaction. The idea of being on the wrong side of the IRS sent her into a heated panic. I could nearly see into her mind’s eye as she imagined 10 IRS agents bursting through her door and hauling her off to jail.
This all caught me by surprise because I knew what would happen if she postmarked her payment one day late: nothing. I had the advantage of understanding how the IRS dishes out consequences, but she did not so her mind ran wild with anxiety.
The IRS has an ominous reputation, spurred on by stories about Al Capone and scary voicemails from fraudsters threatening legal action if you don’t call and pay your tax debt immediately (always ignore those calls; the IRS NEVER initiates phone calls with taxpayers). While I certainly would not encourage anyone to be cavalier about the IRS, the consequences for mistakes are often not as serious as we might imagine. If you have a little of my grandma’s resting anxiety about the IRS, allow me to clarify what actually happens in response to the most common tax errors.
What if I fail to file a return?
If you fail to file a timely tax return by April 15th, or October 15th with an extension, the penalty is 5% of the unpaid tax due. The penalty is charged monthly for up to 5 months. If the return is filed more than 60 days late, the minimum penalty is $435.
What if I fail to pay the tax that is due?
If you filed a return but did not pay the tax, the penalty is 0.5% of the tax not paid levied every month up to a maximum penalty of 25%. The penalty can be lowered to .25% if you set up installment payments or raised to 1% if it remains unpaid after an IRS notice to levy property.
If you did not file the return or pay the tax due and the failure to file penalty and failure to pay penalty both apply, the failure to pay penalty will reduce the failure to file penalty.
Interest will accrue on the unpaid balance from the due date of the return until the tax is paid. The interest rate is the federal short-term rate plus 3%.
What if I don’t pay enough tax through withholding or estimated tax payments?
If your federal tax due will be more than $1,000, you must pay at least 90% of your expected tax due for this year or 100% of your tax due for last year (110% for high-income taxpayers). If you do not withhold enough from wages, pensions, and Social Security or make sufficient estimated quarterly payments, you could owe an underpayment penalty that is often relatively modest and based on how much you underpaid.
What if I get audited? Only about one in every 250 returns is subject to an audit. In most cases, the IRS will handle discrepancies by sending you a tax notice by mail, allowing you to respond to the notice and pay the tax and interest due. In the actual event of an audit, additional penalties will apply if the IRS determines that mistakes were due to negligence or fraud.
For negligence, the penalty is 5-20% of the additional tax due. For fraud, something done knowingly and willingly, the penalty is 75% of the tax owed.
Cases of extreme fraud can be treated as tax evasion, for which it is possible to be prosecuted and sentenced to jail; however, less than 1,500 of the 150 million taxpayers in 2015 were indicted for tax evasion. Most indictments are related to taxpayers who concealed assets or income (like a bank account or income from a side hustle) and who do not claim the assets or income even after a tax notice or audit.
I didn’t pay on time. Now what?
In the case of my grandma’s $100 tax payment that ran the risk of being postmarked a day late, the worst she could have expected was a late payment penalty. The 0.5% penalty on her $100 payment would have amounted to $0.50. Anything under a dollar, the IRS is generous enough to let go.
In cases with more substantial underpayments, the IRS can issue a tax lien or levy. They can garnish your tax refund and wages or seize property such as financial accounts, cars, and homes.
One thing the IRS can no longer do is damage your credit. Starting in 2018, tax liens are no longer reported by any of the three major credit reporting agencies.
Ultimately, people who attempt to file and pay on time and are honest in their reporting to the IRS suffer few consequences beyond penalties and interest. So, yes, try to file and pay on time but if you miss the deadline by a day, you need not worry about anyone coming to knock down your door.