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Don't be caught unaware: penalties, interest for late filing or too little withholding

In this Thursday, Jan. 9, 2013 photo, H & R Block public accountant, John Lee, explains how to file the 2013 1040-ES IRS Estimated Tax forms at his H & R Block tax preparation office in the Echo Park district of Los Angeles. “The United States income tax is a pay-as-you-go tax, which means that tax must be paid as you earn or receive your income during the year,” the IRS says. “You can either do this through withholding or by making estimated tax payments.” (AP Photo/Damian Dovarganes)

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In this Thursday, Jan. 9, 2013 photo, H & R Block public accountant, John Lee, explains how to file the 2013 1040-ES IRS Estimated Tax forms at his H & R Block tax preparation office in the Echo Park district of Los Angeles. “The United States income tax is a pay-as-you-go tax, which means that tax must be paid as you earn or receive your income during the year,” the IRS says. “You can either do this through withholding or by making estimated tax payments.” (AP Photo/Damian Dovarganes)

WASHINGTON - Paying taxes is hard enough. Don't let the total payment due rise because of penalties and interest.

"To me, one dollar out of my pocket is significant," said Dave Duval, TaxAudit.com's vice-president of consumer advocacy. "It's another tax, it's another per cent. It adds up."

There are penalties if you fail to file your tax return, or if you file it late. There are late payment penalties if you didn't have enough withheld or didn't pay enough in estimated taxes.

"You may also have to pay a penalty if you substantially understate your tax, understate a reportable transaction, file an erroneous claim for refund or credit, file a frivolous tax submission, or fail to supply your SSN or individual taxpayer identification number," the Internal Revenue Service says. "If you provide fraudulent information on your return, you may have to pay a civil fraud penalty."

On top of that, there's interest assessed on money that's past due.

"The United States income tax is a pay-as-you-go tax, which means that tax must be paid as you earn or receive your income during the year," the IRS says. "You can either do this through withholding or by making estimated tax payments."

For many, "the challenge is not figuring out how much to pay but coming up with the cash to do it," said Barbara Weltman, a contributing editor to "J.K. Lasser's Your Taxes 2014."

"The money comes in the door and they use it to pay bills," she said. "That's where the challenge comes in."

The IRS has made it easy to get an extension to file taxes beyond the April 15 deadline. But that doesn't mean you can delay paying whatever you may owe the U.S. Treasury.

"You have to pay what you owe by April 15," Weltman said.

"You do want to pay as much of the tax as you can so you won't be penalized for a late payment penalty."

The late payment penalty is one-half of 1 per cent of the unpaid tax per month. However, if the total of all your tax payments — withholding and any estimated tax payments, plus any other payments made before April 15 — is at least 90 per cent of the total tax due, you generally won't be assessed the penalty during the period of the extension.

For future tax years, the IRS has a withholding calculator to help you figure out if you are having enough taken out of each paycheque to avoid penalties.

It's important to file your return even if you don't have the money to pay the taxes due. The failure-to-file penalty is normally 5 per cent for each month that a return is late, up to a maximum 25 per cent. "The penalty is based on the tax not paid by the due date (without regard to extensions)," according to the IRS.

For those who file on time but didn't have enough withheld or didn't pay sufficient estimated taxes, they may be charged interest on the underpayment. The rate is variable, equal to the federal short-term rate plus 3 per cent. For all of 2013 and the first quarter of 2014, the interest rate is 3 per cent.

However, you might be able to avoid the interest charges if your total payments for the year equal at least 90 per cent of what your final payment will be, if you owe less than $1,000 or if the taxes you paid at least equaled your 2012 tax bill.

.Nina Olson, the national taxpayer advocate, said her office did a study on whether assessing penalties affected future taxpayer behaviour.

"The answer is no, it didn't," she said in an interview. She questioned whether people were even aware they were paying penalties and could take action to prevent penalties in future tax years.

Tax software programs generally will figure out whether you have to pay any penalties, and include that in whatever money might be due. As a result, many people might not even be aware they're paying penalties

If you find that you are unable to pay whatever tax is due, you might be able to work out a payment plan with the IRS. To be eligible, you must have filed your tax returns, and your tax bill — including interest and penalties — has to be $50,000 or less. You can apply online at http://www.irs.gov/Individuals/Online-Payment-Agreement-Application, or through one of the IRS' Taxpayer Assistance Centers.

If you receive a notification from the IRS, TaxAudit.com has the following advice:

"Don't bury your head in the sand," they say. "Of all the tax mistakes you could make, not dealing with an IRS letter is one of the worst. A simple matter that could be easily cleared up can snowball into a major problem if not dealt with in a timely manner. Seek the help of an expert to ensure that you respond correctly."

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