IRS Cancels $1 Billion in Penalties for Unpaid Taxes, but Reboots Collection Efforts

Those dreaded Internal Revenue Service collection notices are about to resume. 

But the nation’s tax collector is also giving a surprise holiday present to millions of Americans, saying it will waive $1 billion in penalties that piled up on unpaid tax bills during the COVID-19 pandemic. The upshot is that those taxpayers still owe the U.S. for their back taxes, with interest. But the penalties are waived.

The IRS announced the relief late Tuesday for nearly 5 million people, businesses and nonprofit organizations, most making less than $400,000 a year. The one-time reprieve is for taxpayers who owe less than $100,000 per year for 2020 and 2021, when the coronavirus shuttered businesses and the economy. 

The relief is targeted at 4.7 million taxpayers who were not sent automated collection reminder notices in those years, during a portion of which the IRS all but shuttered its operations. The agency temporarily suspended mailing collection notices last year, but continued to log “failure-to-pay” penalties for taxpayers who had earlier received balance-due notice in the mail. 

Given that "unusual situation,” the IRS said, overdue taxpayers — some of whom haven’t received a reminder in more than a year — will start receiving nudges in the mail next month. The agency said its relief will be “automatic,” so taxpayers don’t have to do anything to lock it in.

Penalties for Americans who mess up their annual taxes can be onerous. Those who owe the Treasury Department but don't file a return on time can be charged a penalty of 5% of the tax owed for each month the return is late, up to 25% of the unpaid total. People who file on time but don’t pay what they owe are charged 0.5% of the unpaid taxes for each month they’re late, up to 25%.

The IRS, which has roughly $60 billion in extra funding over 10 years to boost enforcement and service, has pledged not to ramp up audits of people making less than $400,000, a complicated promise given the record number of small businesses formed during the pandemic. Taxpayers failed to pay $688 billion in federal taxes in 2021, according to an IRS revised estimate.

Dean A. Zerbe, the national managing director of tax consulting firm Alliant Group, called the reprieve on penalties “a reflection of the IRS trying to manage their workload. They don’t want to deal with a deluge of taxpayers coming back.” Zerbe, a former tax counsel to the U.S. Senate Committee on Finance, added, “They’re trying to find a path that will encourage people to come in, so they won’t have to put a lot of manpower into tracking them down.”

Nearly seven in 10 Americans eligible for the new relief have income under $100,000 per year, the IRS said, and the average overdue taxpayer will save just $206 in penalties. 

But they’ll still owe interest on their late payments. 

That could be painful, as the IRS’s rate, which changes quarterly, is based on the Federal Reserve’s benchmark short-term rates, which are now at a 16-year high. The IRS rate is now 8% a year. In the three months before the pandemic emerged, it was 3%. The tax agency compounds its rate daily, which means the longer a taxpayer takes to pay up, the more they owe. People who already paid the penalty will get a refund.

“As the IRS has been preparing to return to normal collection mailings, we have been concerned about taxpayers who haven't heard from us in a while suddenly getting a larger tax bill,” Commissioner Danny Werfel said in a statement. “The IRS should be looking out for taxpayers, and this penalty relief is a common-sense approach to help people in this situation.”

In response to the pandemic, the federal government sent individuals and businesses of all sizes roughly $6.8 trillion in relief payments, credits, tax breaks and unemployment checks — all as the IRS’s operations were partially or completely shut down in 2020, the first year of the pandemic. The shuttering spawned a massive pile-up of unprocessed returns and frustration in taxpayers, whose unanswered calls to IRS hotlines spiked five-fold.

In 2021, Americans experienced “unprecedented processing and refund delays,” a report by the National Taxpayer Advocate, the IRS’s official watchdog said, adding that the agency at the time was “in crisis.” By the end of 2022, 13.3 million paper returns were still unprocessed, a huge backlog. Things were largely back to normal by this year.

Households received nearly $1.8 trillion in direct payments and unemployment checks during the pandemic, according to the Committee for a Responsible Federal Budget, a think tank in Washington, D.C. Small businesses got roughly $1.5 trillion. Those figures don’t include additional trillions for health care, loans, grants and tax breaks, figures that the IRS had to sort through on taxpayers’ returns.