What would you do with an extra $37,825?
Would you pay down your mortgage? Buy a new car? Take a nice vacation? Or invest it back into your business?
Personally, I’d put it toward my mortgage. I’m currently on a debt-free journey, so the thought of having an extra $37,825 to throw at debt sounds amazing.
But unfortunately, a recent client of mine didn’t have those options. Instead, he now owes the IRS $37,825 in penalties and interest from two years of unfiled tax returns. And that doesn’t even include the taxes he owed for those years.
When I first saw the numbers, I cringed. As a tax practitioner, I hate seeing money wasted on penalties and interest because it’s money that could have been used to do something else.
So I wrote this article to help other business owners avoid ending up in the same situation. I’m going to break down the numbers of the $37K tax bill, explain how business owners end up falling behind in the first place, and share three simple things you can do to avoid wasting thousands of dollars on unnecessary IRS penalties and interest.
The $37,825 Tax Bill From Two Unfiled Tax Returns
I want to start by breaking down where the $37,825 came from because many taxpayers don’t realize how quickly penalties and interest can add up.
Let’s start with the biggest penalty.
The Failure-to-File Penalty
When you don’t file your tax return by the tax filing deadline (generally April 15th, or October 15th if you filed an extension), the IRS can assess a Failure-to-File penalty.
This penalty is generally 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25%. For my client, the Failure-to-File penalties alone totaled more than $18,000. That’s right, the IRS assessed over $18,000 simply because the returns were NOT filed on time.
The Failure-to-Pay Penalty
The next penalty is the Failure-to-Pay penalty.
As a business owner or self-employed individual, you are required to pay taxes throughout the year by making estimated tax payments. If there is a remaining balance at the time of filing, it should be paid with the filing of your tax return.
One mistake I see all the time is taxpayers thinking that a tax extension extends the time to pay. It doesn’t. An extension gives you more time to file your return, not more time to pay your taxes.
The Failure-to-Pay penalty is generally 0.5% of the unpaid tax for each month or part of a month the balance remains unpaid, up to a maximum of 25%. For my client, the Failure-to-Pay penalties added another $7,755.45 to the balance.
The Underpayment of Estimated Tax Penalty
If you don’t make enough estimated tax payments throughout the year, or you pay it late, the IRS may also assess an Underpayment of Estimated Tax penalty.
For this client, that penalty was relatively small compared to the others.
Interest
Finally, there is interest.
The IRS charges interest on unpaid taxes, penalties, and other amounts owed. For this client, interest added another $11,601.77 to the bill.
When you add everything together, the result is a staggering $37,825.79.
- Failure-to-File Penalties: $18,178.42
- Failure-to-Pay Penalties: $7,755.45
- Underpayment Penalty: $290.15
- Interest: $11,601.77
And remember, this does not include the taxes owed on the income, which is another $80,000.
Now here’s the really crazy part. The penalties and interest don’t stop once they’re assessed. They continue to accrue until the balance is paid in full. That’s why tax debt tends to snowball over time. The longer you wait, the more expensive it becomes.
This is exactly why I cringe when I see taxpayers ignore tax notices or put off filing returns. What starts as a tax problem can quickly turn into a much bigger and much more expensive problem.
How Business Owners End Up in This Situation
Most business owners don’t end up with unfiled tax returns because they’re trying to avoid paying taxes. They end up here because they’re trying to do everything themselves.
When you start a business, you’re usually doing all of the jobs yourself. You’re the salesperson, the marketer, the customer service representative, the operations manager, the bookkeeper, the payroll department, and the tax department—all while trying to provide the service or product your business sells.
So what happens?
The bookkeeping falls behind.
Without accurate books, the tax returns can’t be prepared.
One unfiled return becomes two. Then the IRS starts sending notices, such as a CP59, asking about your missing tax returns. Meanwhile, penalties and interest continue to grow silently in the background. Before long, what started as a bookkeeping problem has now turned into a tax problem.
I see it all the time. By the time a business owner reaches out to me, they’re already years behind and are overwhelmed because they don’t know where to start.
3 Things You Can Do to Avoid This
If there’s one thing I hope you take away from this story, it’s that most of these penalties were avoidable. Here are three things you can do to avoid giving all of your hard-earned money to the IRS.
1. File Your Tax Return ON TIME
The tax filing deadline is April 15th every year. If you can’t file by April 15th, file an extension by April 15th. An extension gives you until October 15th to file your return. And if October rolls around and you’re still missing a document or waiting on information, file the return anyway and amend it later if needed.
An imperfect return filed on time is usually much better than no return at all.
2. Pay Your Taxes Throughout the Year
Don’t wait until tax season to think about taxes. As a self-employed individual, you should be paying taxes throughout the year by making quarterly estimated tax payments. Doing this helps spread the tax burden over the year and reduces the risk of underpayment penalties and a large balance due at filing time. But if you do end up owing more than you can pay by April 15th, don’t ignore it.
The IRS offers Installment Agreements that allow taxpayers to pay their balance over time. In addition to helping you get back on track, an approved Installment Agreement generally reduces the Failure-to-Pay penalty from 0.5% per month to 0.25% per month while the agreement remains in effect.
The key is to take action. The longer you wait, the more penalties and interest continue to add up.
3. Ask for Help Before You’re Overwhelmed
This is probably the biggest lesson from this client’s story.
Most business owners are great at what they do. They know how to provide their service, manage customers, and grow their business. What they don’t always know is bookkeeping, tax compliance, payroll, and IRS rules.
And that’s okay.
You don’t have to do everything yourself.
When things start falling behind, ask for help. Whether that’s an Enrolled Agent, CPA, tax attorney, or qualified bookkeeping professional, getting help early is almost always less expensive than cleaning up a mess later. The sooner you ask for help, the easier it is to get caught up and avoid costly penalties and interest.
Don’t Let Tax Debt Get More Expensive
If you’re behind on tax filings because you are missing your tax documents, don’t panic. In my next article, How to Get Copies of Missing Tax Documents From the IRS, I’ll show you how to get copies of your missing tax documents so you can prepare and file those tax returns.
Already have all of your tax documents?
Schedule a Tax Needs Consultation, and let’s get your unfiled tax returns prepared so you can get back into compliance and stop the penalties from continuing to grow.
This content is for informational purposes only and is not intended as tax advice. Every tax situation is different. You should consult with a qualified tax professional regarding your specific situation.
