How IRS Penalties and Interest Can Accumulate

The following information is a true story that comes from one of our cases. It demonstrates how expensive it gets when you fail to file and pay your taxes on time.

This taxpayer’s 2006 tax return was originally due by 04-15-2007, and they extended the filing date until 10-15-2007. They finally got around to filing that tax return on – well, they didn’t. The IRS got tired of waiting, filed a Substitute for Return on 01-12-2009, and sent them a big bill. That got their attention. The taxpayer finally filed their 2006 tax return on 07-09-2009; 21 months after the extended due date. Twenty-one months late.

The way the IRS gets the attention of a taxpayer who doesn’t file is by filing an Automated Substitute for Return (ASFR). They can do that when they know how much money was paid to the taxpayer; in this case they had the copies of their 1099’s. They put that gross income on their tax return but what they never know are the expenses and write-offs, so they leave those parts blank. The net income and the tax on any IRS Substitute for Return is always a lot more than if it the return had been prepared correctly. Once a taxpayer is faced with the prospect of paying more than they have to, now there is an extra incentive to file the correct return.

The taxpayer in this example was a sole proprietor and reported their business income and expenses on the Schedule C of their tax return. That makes filing late even worse because in addition to the income tax, they owed self-employment taxes; think of the Social Security and Medicare taxes taken out of your paycheck every week, except due in a lump sum. These penalties and interest were calculated on the amount of tax that was owed.

The total tax on the correct return was $16,039 and was officially was assessed on 08-24-2009.

The penalties and interest levied on 08-24-2009 were:

  • Penalty for not prepaying tax $343
  • Penalty for late payment of tax $2,303
  • Penalty for filing tax return after due date $3,573
  • Interest charged for late payment $2,840

On 10-22-2012, more than three years later, the IRS levied another penalty of $1,668 for late payment of tax. That brought the grand total the taxpayer owed to $26,766. The penalties and interest was now up to $10,727. That is an increase of 67% over the original tax amount had the taxpayer filed and paid on time.

They never were able to pay the $26,766. They had problems with other years as well. Eventually they owed the IRS more than $54,000 before they were forced to confront the fact that their business wasn’t going to make enough money to support itself. The filed an Offer in Compromise and most, but not all, of their IRS debts had to be written off.

If you have a problem like this you should contact us. We can stop the bleeding and put these problems behind you.