If there are substantial underpayments of taxes in a given tax year, the taxpayer will be penalized. An underpayment is “substantial” if the unpaid tax is the greater of 10% or the amount that should have been paid, or $5,000. For substantial underpayments, the tax penalty imposed is 20% on the unpaid amount. On top of the 20% penalty, substantial underpayments will be subject to the same penalty that ordinary underpayments are charged.
Calculating Tax Penalties and Interest
To calculate the penalty on ordinary underpayments of taxes, the taxpayer must apply the applicable federal short term interest rate (which changes every quarter) plus and additional 3% penalty. The federal short term rate for the first quarter of 2010 is 4%. To calculate the penalty for underpaying taxes in 2010 is a 4% penalty plus the 3% penalty on the tax owed, and the penalties are compounded daily.
If the amount owed qualifies for the substantial underpayments of taxes penalty, an additional 20% on the amount owed will apply on top of the ordinary penalty that compounds daily.
Additional Penalties
Over valuation is seen by the IRS as a form of fraud, and as such, harsh penalties are imposed. For over valuations that are 200% or more and under 400% of the tax amount owed are subject to a 20% penalty on the underpayment that is due to the IRS. If the over valuations are 400% or more of the tax that should have been paid, the IRS will impose a penalty of 40%.
Time Limits to Pay Penalties and Payment Plans
Even if you cannot pay the full amount owed on your taxes, it is best to reflect the accurate amount owed and work out a payment plan with the IRS. The penalties for underpayments are far worse than the interest rate imposed on instalment agreements when done properly. If the tax outstanding is less than $10,000, the IRS will automatically approve a request to make installment payments over time provided that:
- all tax returns have been properly filed within the pat 5 years;
- that the IRS agrees that you are unable to pay the total amount due on your debt;
- and that the taxpayer agrees to pay the total debt within 3 years.
If all three requirements are present and the debt is less than $10,000 total, there is a very good chance that the IRS will have not problem approval an installment request.
Help from a Tax Attorney
The consequence of underpaying taxes and having penalties imposed is an avoidable problem. To understand your tax liabilities and plan for your tax payment, you should contact an attorney who specializes in tax law. The IRS rules can be complicated and confusing, and having a knowledgeable attorney can save you thousands of dollars in penalties down the road.
