Penalties: Failure to File vs. Failure to Pay

If you remember only one thing from this section, remember this: the Failure to File penalty is 10 times worse than the Failure to Pay penalty. Always file your return on time, even if you cannot pay the full amount owed. This distinction appears frequently on the EA exam.

The Two Penalty Types

The IRS imposes separate penalties for two distinct violations:

1. Failure to File (FTF) - Not submitting your tax return by the due date
2. Failure to Pay (FTP) - Not paying your tax liability by the due date

These penalties apply independently, meaning a taxpayer can face one, both, or neither depending on their situation.

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Failure to File Penalty

The Failure to File penalty is the more severe of the two penalties. It applies when a taxpayer does not file their return by the due date (including extensions).

Penalty Rate: 5% of the unpaid tax for each month (or part of a month) the return is late

Maximum Penalty: 25% of the unpaid tax (reached after 5 months)

Example: A taxpayer owes $10,000 and files 3 months late without an extension.

• Month 1: $10,000 x 5% = $500
• Month 2: $10,000 x 5% = $500
• Month 3: $10,000 x 5% = $500
• Total FTF Penalty: $1,500

Minimum Penalty for Returns Over 60 Days Late

If a return is filed more than 60 days after the due date (including extensions), a minimum penalty applies:

Minimum Penalty = Lesser of:

• $510 (for returns due in 2025), or
• 100% of the unpaid tax

This minimum applies regardless of the 5% calculation. For example, if a taxpayer owes only $300 and files 90 days late, the penalty would be $300 (100% of tax owed), not $510.

Fraud Penalty

If the failure to file is due to fraud, the penalty increases significantly:

• 15% per month (instead of 5%)
• Maximum 75% of the unpaid tax (instead of 25%)

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Failure to Pay Penalty

The Failure to Pay penalty is much less severe than the Failure to File penalty. It applies when a taxpayer files their return but does not pay the tax owed by the due date.

Penalty Rate: 0.5% (one-half of one percent) of the unpaid tax for each month (or part of a month) the tax remains unpaid

Maximum Penalty: 25% of the unpaid tax

Example: A taxpayer owes $10,000, files on time, but takes 6 months to pay.

• Each month: $10,000 x 0.5% = $50
• 6 months x $50 = $300 total FTP penalty

Reduced Rate with Payment Plan

If a taxpayer has an approved IRS installment agreement, the Failure to Pay penalty is reduced:

• 0.25% per month (instead of 0.5%) while the payment plan is in effect

Increased Rate After IRS Notice

If the IRS issues a notice of intent to levy and the taxpayer does not pay within 10 days:

• 1% per month (instead of 0.5%)

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How the Penalties Interact

When both penalties apply in the same month, the IRS reduces the Failure to File penalty by the Failure to Pay penalty.

Combined Rate Formula:

• FTF: 5% - 0.5% = 4.5%
• FTP: 0.5%
• Total: 5% per month

This means for the first 5 months, a taxpayer who neither files nor pays faces a combined 5% monthly penalty (the same as just failing to file). However, after 5 months, the FTF penalty maxes out at 22.5% (4.5% x 5 months), but the FTP penalty continues accumulating.

Maximum Combined Penalties:

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Interest on Underpayments

In addition to penalties, the IRS charges interest on any unpaid tax, penalties, and interest from the due date until paid in full.

Interest Rate: Federal short-term rate + 3 percentage points

Compounding: Daily (not monthly or quarterly)

Rate Updates: Quarterly (January, April, July, October)

Important: Interest applies to penalties as well as unpaid tax. The IRS can waive interest only if it resulted from IRS error or delay.

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Penalty Relief Options

First-Time Penalty Abatement (FTA)

The IRS may remove Failure to File and Failure to Pay penalties through First-Time Penalty Abatement if the taxpayer meets these requirements:

1. Clean compliance history - No penalties in the prior 3 tax years
2. All required returns filed - Or filed a valid extension
3. Paid or arranged to pay - Current tax liability is paid or on a payment plan

FTA can be requested by phone or in writing. There is no limit on the dollar amount that can be abated. If the IRS denies FTA, they will automatically consider reasonable cause.

Reasonable Cause Relief

If a taxpayer does not qualify for FTA, they may request penalty relief based on reasonable cause. The taxpayer must demonstrate:

1. They exercised ordinary business care and prudence
2. They were still unable to comply with tax obligations
3. The failure was not due to willful neglect

Examples of reasonable cause:

• Death or serious illness of taxpayer or immediate family member
• Natural disaster or fire destroying records
• Inability to obtain records despite good faith efforts
• Written advice from the IRS that later proved incorrect
• Undue hardship from paying tax liability

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Comparison Table: Failure to File vs. Failure to Pay

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Exam Tips

1. The 10x rule: Filing penalty (5%) is 10 times worse than payment penalty (0.5%)

2. Always file on time: Even with no money to pay, filing prevents the larger penalty

3. 60-day minimum: Remember $510 for 2025 returns or 100% of tax, whichever is less

4. Combined max is 47.5%: Not 50% (because FTF is reduced by FTP during overlap)

5. Interest compounds daily: But rates are updated quarterly

6. FTA requires 3 clean years: No penalties assessed or abated in prior 3 years