Interest and Income Tax
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If you're more of a borrower than an investor, you probably cringe whenever you hear the word interest. Now, step out of that context and imagine yourself preparing for the tax filing deadline. Isn't that a load of stress as well? What might be worse is when you combine these two headaches: interest and income tax.
Interest Income
It may not be as bad as you think. For one, interest income is any earning you get from investments: this may be for a personal income statement or a company's. Interest income has nothing to do with compounding your taxes with a certain interest rate. It does mean, however, that you might have to declare it when you file for taxes.
Some related questions on interest income that are answered by the IRS can be found here.
Interest Expense
The counterpart of interest income is interest expense which is any expense that is the cost for borrowing money. Some interest expenses are completely ignored during tax time, while some are fortunately tax-deductible, such as home mortgage interest or a qualified student loan. For more details, you must consult the guidelines provided by the internal revenue agency.
This IRS page lists several questions related to interest expense and points you to related reading as well.
Interest for Late Tax Filing and/or Underpayment
So you've seen how interest participates when you file for taxes—but what about late filing or underpaid taxes? Penalty charges are applied to the pending dues, calculated based on how long it's been since the payment deadline as well as the current interest rate. Penalties are composed of the Failure to File Penalty, the Failure to Pay Penalty, and Interest.
Failure to File Penalty means you have to pay 5% monthly from deadline to the time you've finally filed your tax return, up to 25%. Failure to Pay Penalty means you have to pay 0.5% for every month you have not yet completed your payment. Interest depends on how much you need to pay. The interest rate to be used is the federal short-term rate plus 3%. This is compounded daily.
There are many different situations that result in different combinations of penalties. For starters, read the list of FAQs under the keywords "penalty for underpayment" here.
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