IRS miscalculates interest on recent notices

In July, the Internal Revenue Service announced an interest rate calculation error on notices sent to taxpayers. The IRS uses form CP2000 when discrepancies exist between what is reported on a taxpayer's return and information reported by an employer or bank.

These notices generally involve changes to credits or deductions, which would result in a higher tax bill. Along with a tax increase, there is usually a penalty and interest for the underpayment. Many of the recent notices did not include any interest. On some others, the total interest listed was $1.

The current interest rate for the third quarter is actually three percent for underpayments by individuals. The rate for large corporate underpayments is five percent. The IRS fixed the calculation errors and planned to send updated letters.

Penalties along with interest can increase your tax burden

On any unpaid tax balance, interest will accrue from the time the tax was due. Two possible penalties can increase what you owe. However, IRS penalty relief could be available depending on your individual circumstances.

The more serious penalty is for filing a late return. Each month that passes after April or October (if you filed for an extension) results in a five percent penalty. This caps out at 25 percent of the amount that you owe. On a tax bill of $5,000, this would add an extra $1,250. Even if you cannot pay the full amount of the tax owed, it is often best to file before the deadline.

The second penalty kicks in when you do not pay the taxes owed by April 15. This penalty is .5 percent for each month that the payment is late. A partial month will trigger the additional .5 percent, as well. Even when you file for an extension to file, you are on the hook to pay at least 90 percent of what you owe to avoid the penalty. Any balance is due when you file in October.

For those who make estimated payments, a missed quarterly payment will not generally result in a penalty. At tax time, if the total estimated payments were not enough to cover the tax you owed on self-employment income, rental receipts, alimony, or the gain from the sale of an asset, you may be charged a penalty.

Penalty abatement - when can you avoid penalties?

An installment payment plan is one way that you may be able to avoid penalties. However, there still may be interest charged on the amount that you owe. When taxes, penalties and interest add up to something that you might never be able to pay, an offer in compromise might be one way to take care of the tax debt. This option allows you to pay less than you owe, but is only available in limited circumstances.

If you have a reasonable cause, you may be able to request penalty abatement. A hospitalization that prevented you from filing on time or paying your bill may count. The review is highly fact specific and the standard can be quite high.

When you have questions about an IRS letter, an experienced tax attorney can better explain your available options. There may be relief from the penalties and interest, but the sooner you deal with the issues the better.