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TAXING PENALTIES

taxthinking_041414Are you considering filing your personal tax return after April 15th because your records are in disarray, you owe taxes and your bank account is drained or because you would rather go shopping. There is good news and bad news.

BAD NEWS

Unless you have applied for an extension and have made the proper payments, you may be opening a Pandora’s Box of financial problems. The penalties for submitting your tax return late can build to a fortune over time with a failure to file penalty, failure to pay penalty and accruing interest of the balance due. If you are self-employed and do not file for several years then you could also face a reduction in your future Social Security benefits.

The failure to file a required return penalty is 5 percent for each month or portion of a month the failure to file continues up to a maximum of 25%. The failure to pay taxes penalty is 1/2 percent per month or part of a month that the failure to pay continues and also maxes out at 25%. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100% of the unpaid tax. The current interest rate for past due taxes is 3%.

If the April 15th deadline does not work for you then file for a six-month extension (IRS Form 4868). This will prevent a failure to file penalty. If you owe taxes, make sure you pay 90% of the total amount you owe, or 100% of the tax you paid on your previous year’s tax return. This will avoid the failure to pay penalty.

Perhaps a bigger penalty is the impact on future Social Security benefits. While W-2 information is reported to Social Security, self-employment income and taxes you paid, come from the tax return you file. If you are due to a refund for withholding or estimated taxes, you must file your return within 3 years of the return due date. if you are self-employed and do not file your federal income tax return, any self-employment income you earned will not be reported to the Social Security Administration and you will not receive credits toward Social Security retirement or disability benefits.

The impact on future Social Security benefits could be devastating. If your benefits are reduced by $100 per month and you begin drawing benefits at 62 and live to 82, you will lose $24,000 in benefits.

GOOD NEWS

If you screw up your relationship with the IRS over late filings and taxes and subsequently get back on track the IRS offers a little known abatement or refund on the failure to file and failure to pay penalties. The relief is a one-time abatement for the first year you screwed up. There are no second chances at bat. You get the relief once. Under the current law the IRS cannot provide any relief from the interest penalty.

While the one-time penalty abatement is good news for anyone in this unfortunate situation, there are a few conditions: you must have filed all required returns or filed or obtained a valid extension of time to file; have paid or made arrangements to pay (e.g., installment agreement) all tax currently due; have not previously been required to file or if returns were filed, had no penalties in the last three years (An estimated tax penalty will not disqualify you for the penalty abatement).

If you qualify then file IRS Form 843.

Bottom Line: Don’t mess with the IRS by ignoring April 15th!

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