Unpaid & Underpayment Tax Penalties: Consequences of Unpaid IRS Taxes

unpaid tax penaltiesApril 15th is the deadline for most individuals to pay and file their taxes. Some individuals may request an extension to file, but there really is no request for an extension to pay. If you request an extension to file you must pay 90% or more of the taxes that you owe in order to prevent the failure to pay penalty. Interest and penalties on unpaid taxes start being charged on April 15th. Penalties and interest are the same for unpaid amounts vs underpaid tax amounts. Below are the penalties and interest on these amounts.

Failure to Pay (Unpaid) and Underpayment Penalties & Interest

  • Penalty: Underpayment and unpaid tax penalties are calculated from the due date of taxes (typically April 15th). This penalty is .5% of the tax owed for each month or part of a month. The maximum this penalty can be is 25% of the total tax owed. This penalty will be increased to 1% if the tax remains unpaid 10 days after the IRS issues a notice of intent to levy. This rate will drop for individuals to a quarter percent for any month in which an installment agreement is in effect.
  • Interest: The interest rate you are charged on unpaid and underpaid tax amounts changes every three months. It is determined by the federal short-term rate plus 3% and interest is compounded daily. This interest rate is typically about 4% per year. Interest will continue to add up as long as taxes are owed, there is no maximum amount of interest owed.

Further Consequences of Unpaid Taxes

Once the IRS realizes that taxes are owed they will begin their automated collection system (ACS). When the ACS starts they will begin by assessing taxes owed and will add up penalties and interest and send various notices to the owing taxpayer as noted above. This process will keep moving along its set path until the taxpayer has paid their taxes or taxes have been resolved in some other way. Below are the basic steps the ACS follows although it sometimes may be different depending upon the IRS’s perception of what actions they think you will take.

    • Receive CP Letters: CP Letters are computer paragraph notices. Each notice is noted by a CP number on the top of the letter. The first letter you receive will assess you with a tax amount owed and will demand payment of that amount. These notices will continue for a period of 2-6 months depending upon how much is owed in tax. Each letter will get a bit more demanding and threatening. The IRS does not take any collection action when these notices are being sent out but they do continue to notify you of your additional penalties and interest you are being charged.
    • Notice of Federal Tax Lien: If no action is taken when CP notices are received the IRS may choose to place a lien on the taxpayer’s assets. A tax lien is placed in order to secure payment of taxes. A tax lien is the government’s claim to your assets. This means if you try to sell that asset the IRS will be able to take its cut of the funds before you do.
  • Tax Levy: A tax levy is the last step the IRS will take if no actions are taken to settle or pay the taxes owed. A tax levy is the legal seizure of property by the IRS in order to satisfy unpaid taxes. Collections only get to this point if the taxpayer continues to ignore requests of the IRS and takes no action to work with them on another resolution. Depending on your financial situation the IRS may implement any of the following forms of a levy.
    1. Wage Garnishment: The IRS will contact your employer and demands that they take out a portion of your paycheck and send it over to the IRS.
    2. Bank Levy: The IRS will contact your bank and your bank will immediately freeze your account so you cannot take any money out. The IRS will then require the bank to send over funds from the account in order to satisfy the unpaid taxes.
    3. Asset Seizure: The IRS can seize assets such as cars, homes, boats, and anything else they think they can sell in order to gain funds to satisfy unpaid taxes.

It is important to know that the IRS has many great programs available for individuals that have unpaid taxes. If you work with the IRS it is very likely that you will be able to eliminate or limit penalties, interest and other consequences that unpaid taxes may have. If you are unsure of the best way to handle your unpaid taxes it is a good idea to consult with a tax professional to find the best solution.