How to Calculate Taxes & Penalties

To prepare a federal income tax return three types of income are calculated--total income, adjusted gross income and taxable income. Taxable income is used to calculate your tax liability, or the amount of income tax you owe the IRS. The IRS will impose penalties on these tax payments for a handful of different situations. Learn to avoid penalties by calculating and making estimated tax payments.

Difficulty: Moderate

Instructions

Things You'll Need:

• Pen Paper Calculator IRS manual containing tax information about deductions, exemptions Proof of income paperwork

How to Calculate Taxes

1. Calculate your total income by adding up all sources of income. This includes any money given to you in the form of wages, tips, dividends, interest, capital gains, or alimony, for example.

2. Take any allowed adjustments as indicated in your IRS manual to calculate your adjusted gross income.

3. Identify which deductions and exemptions you are eligible for and include this in your equation. This final figure is your "adjusted gross income." Deductions and exemption eligibility is discussed in your IRS manual.

4. Subtract from your adjusted gross income the larger of the two: either your itemized deductions or the standard deduction.

5. Subtract the value of your exemptions from the amount in step 4 to arrive at a figure for your taxable income. The value of each exemption changes from year to year. For example, 2009 exemptions are each worth $3,650.

6. Once you know your taxable income consult a tax table to determine which tax bracket you fall into, which will indicate the percentage of your income that will go to taxes.

Calculating IRS Tax Penalties

7. Calculate any "Failure to File" penalties by adding five percent to the total owed for each month the tax return is late. Calculations can stop on the day you file your return. For example, if you are more than five months late multiply the balance due by 25 percent.

8. Figure in .5 perent penalty for each month the tax is not paid in full when calculating any "Failure to Pay" penalties. This percentage will keep being tacked on until the balance is paid in full.

9. Calculate any interest due on late or unpaid taxes by looking at the current federal short-term interst rate and adding three percent to it. Interest begins accruing on the date the return is due, and ends the day the IRS receives payment in full. The interest rate on unpaid Federal tax changes every three months.

Tips & Warnings

• If you voluntarily step forward to correct an error of deficiency payment before it gets discovered via an audit you have the best chance of successfully being granted penatly abatement--where penalties charged are decreased. Write to the IRS to request a penalty abatement. Make sure your letter is clear and concise, and adequately describes the reason behind the error. It generally takes the IRS one to two months to make any adjustments.
• Be sure to double check your calculations before filing your return. The IRS can and will charge interest and penalties regardless of the reasons for the "payment defiency." This means that even a mathematical error can cause you to owe additional monies to the IRS in the form of interest or penalites.

Resources

• AARP 2009 1040 Tax Calculator
• Federal Tax Bracket Table

[demian9]

on 4/20/2009 Please provide an example of your calculations in step 3 of the Penalties section. Compounding interest daily is clear. But is this a) yearly interest or b) monthly interest or c) daily interest that accrues? e.g., $1000 owed with 5% late interest (2% short-term 3%IRS rate) =a) ~$50.00 per day -- (1000 * 5%)therefore in 10 days the total due = 1628.89 ??orb) ~$17.25 per day -- (1000 * (5%/30)therefore in 10 days the total due = 1173.82 ??or b) ~$0.14 per day -- (1000 * (5%/365))therefore in 10 days the total due = 1001.37 ??[not taking into account the monthly penalty for unpaid balance)