Finding out that the Internal Revenue Service (IRS) believes you underpaid your taxes is certainly a frightening experience. After all, you can count on the government to get their money no matter what. In severe cases, those accused of failing to meet their tax obligations might even face federal prosecution.
Regardless of whether or not the IRS alleges your tax mistakes are a criminal matter, you can expect that there will be some financial penalties assessed against you. The IRS is notorious for aggressively adding to tax debts by collecting interest and assessing penalties or fines.
How much can you expect to pay in those extra costs beyond the original tax debt?
The interest can add up quickly
As soon as you have failed to meet your tax obligations by a specific deadline, interest will start accruing on the unpaid amount. If you file a tax return and the IRS reviews it six months later and determines there was an underpayment, you will have to pay interest for the entire length of time that has passed since the tax was initially due.
The amount you pay could be significant. Typically, the IRS assesses an interest rate that is 3% above the federal short-term lending rate. The IRS usually adjusts the interest rate quarterly. However, the interest compounds daily, meaning that it will add up more quickly than you realize, especially with a high principal balance.
What penalties or fines will you need to pay?
The financial penalties for underpaying your taxes can also be significant. Typically, the IRS assesses two kinds of penalties. You could face a negligence penalty if you made some kind of mistake or oversight.
The IRS could also assess a penalty if you made a substantial error, which typically means a mistake that would alter your tax responsibilities by 10% or more. The penalty could be 20% of the taxes owed. The good news is that typically the IRS can only assess one of the two penalties against you. Overall, the interest and penalties assessed when someone fails to pay their income taxes in full and on time could add thousands of dollars to the total balance owed.
Learning about the consequences of a tax mistake can help those hoping to resolve a tax issue amicably with the IRS.