How a $7,000 IRS Bill Becomes $15,000

You owed the IRS $7,000. You did not have it that month, so you left it. Eighteen months later the notice says $15,000 and you cannot work out how a number doubles without anybody deciding that it should.

Nobody decided. IRS penalties are automatic, they stack, and interest runs on the penalties as well as the tax. Here is exactly how the arithmetic works, and the three ways contractors get part of it removed.

Two separate penalties, not one

Filing late and paying late are different failures with different penalties, and you can incur both at once.

• Failure to file: 5% of the unpaid tax for each month or part month the return is late, capped at 25%.
• Failure to pay: 0.5% of the unpaid tax for each month or part month, also capped at 25%.

When both apply in the same month the failure-to-file penalty is reduced by the failure-to-pay penalty for that month, so the combined rate is 5% rather than 5.5%. Run that to its limit and the worst case is 47.5% of the tax: 22.5% for filing and 25% for paying, before a dollar of interest.

The one that surprises people

If a return is more than 60 days late, there is a minimum failure-to-file penalty regardless of how small the balance is. For 2026 returns it is the lesser of $525 or 100% of the tax owed. A contractor who files eight months late owing $600 does not pay a proportionate penalty; they pay $525.

Interest is the part everyone underestimates

Interest is charged from the original due date, not from when the IRS notices. The rate is the federal short-term rate plus three percentage points, reset quarterly, and it compounds daily. For the third quarter of 2026 the underpayment rate is 7%.

Interest accrues on the penalties too, not only the tax. That compounding is what turns a gap you meant to close next quarter into a balance you have to finance.

Three ways to get penalties removed

Penalties are assessed automatically, which also means a meaningful share of them come off when someone asks properly.

• First-time abatement. An administrative waiver for taxpayers with a clean compliance history — broadly, no penalties in the prior three years, all required returns filed, and any balance paid or under an arrangement. It is granted on the record, not on the story, and it is the fastest route.
• Reasonable cause. Serious illness, a fire or flood at the office, records destroyed, a death in the immediate family. Not “cash was tight” on its own, and not “my bookkeeper left” without more. It needs dates, documents and a clear causal line to the failure.
• Statutory exception. Where you relied on written advice from the IRS itself, or on a specific published position.

Abatement removes the penalty. It does not remove the interest on the underlying tax, though interest charged on an abated penalty comes off with it.

Payroll taxes are a different animal

Everything above concerns income tax. If what you are behind on is payroll tax, the exposure is a different order of magnitude, because part of that money was never yours — it was withheld from your crew and held in trust for the government.

Unpaid trust fund amounts can be assessed personally against whoever was responsible for collecting and paying them, which in a small construction company usually means the owner. That assessment survives the company. If the balance you are carrying is 941 money rather than 1040 money, treat it as urgent rather than as a cash-flow item.

What to do while you are still short

File on time even when you cannot pay. This is the single highest-value move on this page. Filing stops the 5% penalty and leaves only the 0.5% one — a tenfold difference in the monthly rate. Contractors routinely do the opposite, holding the return back because the balance is uncomfortable, and pay ten times the penalty for the privilege.

Then get an installment agreement in place. Once one is active and the return was filed on time, the failure-to-pay rate drops from 0.5% to 0.25% a month. If a notice of intent to levy has been issued and the balance sits unpaid ten days past it, the rate goes the other way, to 1%.

The short version

• Filing late costs ten times what paying late costs. File the return either way.
• Combined penalties top out at 47.5% of the tax, before interest.
• Interest is 7% for Q3 2026, compounds daily, and runs on the penalties too.
• A return more than 60 days late carries a minimum penalty of $525 for 2026 returns.
• First-time abatement turns on a clean three-year record, and it is worth asking for.

General information about how these penalties work, not advice on your situation. Rates and thresholds change quarterly, and abatement depends on your specific compliance history. Accounting Solutions LLP works with construction contractors nationwide.

Disclaimer: This content is provided for educational purposes only and is not legal, tax, accounting, or financial advice. Every situation is unique, so consult your own attorney, CPA, or financial advisor before making decisions based on this information.