There are some penalties that are pretty straight forward and then there is the IRS Failure to File (FTF) penalty 6651(a)(1). The FTF is a 5% per month penalty to a maximum of 5 months or 25% from the due date or the extension date, whichever is later. If the FTF and the Failure to Pay (FTP) penalty run simultaneously, you only pay 4.5% for the FTF penalty and it caps out at 22.5% as the IRS is limiting the combination of the two penalties to 5% overall. That is the good news.
Now, here is the illogical part of the calculation. So, if you have an amount due of $40,000 on the tax due date and you pay the $40,000 the next day, the payment does not have any impact on the FTF penalty calculation. In fact, if you pay the tax the next day and don’t file until the extension date, which means you are 6 months late, you will be responsible for 25% of the original tax due, or $10,000, since the penalty is based on the amount of the tax on the tax due date regardless of paying the entire amount and only have one month outstanding.
Let’s take this a step further on the logic (or lack thereof) of this penalty. The FTF is interest bearing from the due date or the extension date. Believe it or not, the entire penalty gets charged interest on the first day. It takes five months to accrue and interest is charged on the full amount on the due date. Let’s use the example above where the taxpayer owes $40,000 on 4/15, pays the $40,000 on 4/16, and then files on 10/15. The FTF penalty is $10,000, the interest on the $10,000 starts on 4/15, and in 2018 would be over a $1,000.
If you are advising your client, always have them file their return timely or file an extension. Just file even if you can’t pay. This is an expensive penalty and accumulates quickly to 25% plus the interest.