Is it Better to Pay Interest or the Penalty?

Published on: 13:08PM May 16, 2019

A reader replied to our post on the underestimated tax penalty from a couple of days ago indicating that they would rather pay the penalty since the penalty is less than the interest they would owe if they borrowed the money to pay the estimates.

This may have been true a few years ago when the penalty rate was very low, however, the current penalty rate (really an interest charge) is at 6%.  This penalty is also non-deductible so if a taxpayer is in a combined 25% federal and state tax rate, it equates to a rate closer to 8%.

I am fairly certain that most of our farmers do not pay interest at anywhere near 8% on their short-term borrowings.  Therefore, it may make sense to pay the estimated taxes in today's tax environment.

Remember, if you do qualify as a farmer, you only pay one estimated tax payment on January 15 and then you do not have to file and pay until April 15.  In most cases, this will be a better economic decision than trying to file and pay by March 1.  Plus if you are a member of any outside partnership or S corporation, getting your k-1 before March 1 can be very difficult.

Farmers with very low estimated tax requirements may want to skip the estimates if the penalty is very low.

For example, assume a farmer's 2018 tax liability was $1,200.  He expects to owe about $50,000 for his 2019 tax filing.  If he waits to pay this tax until April 15, his penalty for paying estimated taxes is about $36 ($1,200 X 6% times 50%).  At that amount, it may not be worth the hassle of trying to file and pay by March 1, plus the time value of money on making the $50,000 payment on March 1 is about $370 (assuming 6% interest for 45 days).  Remember, the penalty is only on the $1,200 2018 tax not the $50,000 owed for 2019.