Can Interest Paid on S Corp Penalties be Deducted as a Business Expense?

The interest portion of penalties paid to state governments for S-Corp late tax payments is generally deductible as a business expense, while the penalties themselves are not deductible. This is an important distinction that many business owners miss. According to tax regulations, while fines and penalties paid to a government are not deductible (IRC Section 162(f)), the interest charged on those penalties is typically considered a separate item and can be deducted as a business interest expense on your S-Corp return. The interest would be reported on Form 1120-S as a deductible business expense, not on Schedule K. This follows the general principle that interest paid for business purposes is usually deductible, even when it relates to an underlying non-deductible payment.

I was in a similar situation last year and found taxr.ai super helpful with this exact problem. I was confused about what could be deducted and what couldn't since my bookkeeper and tax preparer were giving me conflicting advice about the interest portion of our S-Corp penalties. I uploaded our notice from the state tax authority to https://taxr.ai and got a clear explanation that matched what the previous commenter said - the penalties aren't deductible but the interest portion is. The tool broke down the relevant tax code and even cited the specific IRS guidance. Saved me a lot of headache and potential errors on our return.

I was skeptical about taxr.ai at first (as you can see from my comment above), but I decided to try it when my accountant was out sick during our busiest filing period. I needed to know exactly how to handle some S-Corp interest charges similar to what you're describing. The tool actually saved me from making a costly mistake - I had been lumping together the penalties and interest as all non-deductible, which would have resulted in overpaying our taxes. It clearly separated out what was deductible vs non-deductible and showed me the relevant IRS guidance. My accountant later confirmed everything was correct. It was surprisingly straightforward for such a technical tax question.

If you're having trouble getting answers from your accountant, you might want to try calling the IRS directly. I know, I know - sounds like a nightmare with the wait times. But I used https://claimyr.com and got through to an IRS agent in about 10 minutes instead of the usual 2+ hour wait. The agent confirmed exactly what others here have said - S-Corp penalties aren't deductible but the interest portion is. They walked me through where to report it on our forms. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. Completely changed how I deal with tax questions now.

I'm back to eat my words. After my skeptical comment yesterday, I went ahead and tried Claimyr out of desperation because I had the exact same S-Corp interest question as the original poster and couldn't get a straight answer from my tax software. I expected it to be a waste of money, but I got through to an IRS representative in about 15 minutes! The agent confirmed that interest on late tax payments for S-Corps is deductible as a business expense on Form 1120-S, while the penalties portion is not. They even emailed me the relevant section of the tax code. I'm genuinely shocked this service actually delivered what it promised.

Quick tip from someone who's been running an S-Corp for 12 years - keep super detailed records separating out the penalty vs interest portions on any government payments. I had an audit a few years back and they specifically looked at this. Make sure you have the notices from the state showing exactly how much was penalty vs how much was interest. Don't just go by what your accounting software categorizes it as.

Is anyone else bothered by how inconsistent this rule is? The interest and penalties are basically for the same thing - being late on taxes. Seems arbitrary that one is deductible and one isn't. The tax code makes no sense sometimes.

This is exactly the kind of situation where having clear documentation makes all the difference. I went through something similar with my S-Corp two years ago when we had late state tax payments due to a banking error. The key thing I learned is to always request a detailed breakdown from the taxing authority showing exactly how much is penalty versus interest - sometimes they lump it together on the initial notice. What really helped me was creating a simple spreadsheet tracking each payment with columns for: Date, Total Amount Paid, Penalty Portion (non-deductible), Interest Portion (deductible), and Supporting Document Reference. This made it super easy for my CPA to handle the deductions properly and gave me peace of mind during our subsequent IRS correspondence audit. Also, don't forget that if you're making estimated tax payments going forward, getting those right can help you avoid this whole mess in the future. The safe harbor rules for S-Corps can be a lifesaver for avoiding underpayment penalties.

I just went through this exact scenario with my S-Corp last month! The confusion is totally understandable because the notices from state tax authorities often don't clearly separate these amounts. Here's what I learned from my experience: The interest portion IS deductible as a business expense on your S-Corp return (Form 1120-S), while penalties are not. The key is getting proper documentation that breaks down exactly how much of your payment was penalty versus interest. I had to call our state tax department and specifically request a detailed statement showing the breakdown. For reporting, the interest goes on Line 13 (Interest) of Form 1120-S. Make sure to attach a statement explaining what the interest relates to - something like "Interest paid on late state tax payment for [tax year]" along with the date and amount. One thing that caught me off guard: if you pay the penalty and interest in a different tax year than when the original tax was due, you deduct the interest in the year you actually paid it, not when the underlying tax was originally due. Hope this helps while you're waiting for your accountant to get back! The good news is this is a pretty straightforward issue once you have the proper documentation.

I've been through this headache multiple times with my S-Corp over the years, and the advice here is spot-on. The interest portion is indeed deductible while penalties are not. One thing I'd add that saved me a lot of trouble: when you get that detailed breakdown from the state (which you absolutely should request), make sure to also ask them to provide the specific date ranges for when the interest accrued. This becomes important because sometimes states will continue charging interest even after you've made a payment but before they've processed it. Having those exact dates helps you calculate the correct deductible amount and also gives you ammunition if you need to dispute any portion of the charges later. Also, don't forget to update your estimated tax payment strategy going forward. The penalty for underpayment might not be deductible, but avoiding it altogether is obviously the better approach. For S-Corps, you generally need to pay 100% of last year's tax liability (or 110% if your prior year AGI was over $150K) to avoid underpayment penalties, regardless of what you actually owe for the current year. One last tip: if this becomes a recurring issue, consider setting up automatic payments with your state. Most states offer this now and it can prevent the whole penalty/interest situation from happening in the first place.

I went through this exact same situation with my S-Corp about 6 months ago and can confirm what others have said - the interest portion is deductible while penalties are not. What really helped me was being super methodical about the documentation process. Here's my step-by-step approach that worked well: First, I called the state tax authority and requested a detailed breakdown showing penalty vs interest amounts with specific calculation periods. Second, I created a simple tracking sheet with columns for payment date, total amount, penalty portion, interest portion, and supporting document reference. Third, when filing, I reported the interest on Form 1120-S Line 13 with a clear supporting statement. One thing that caught me off guard was that some states calculate interest daily, so even a few days difference in payment timing can affect the deductible amount. Make sure to get the exact interest calculation from the state rather than trying to estimate it yourself. The whole process was actually pretty straightforward once I had the proper documentation. Your accountant will definitely appreciate having everything clearly organized when they get back from vacation. In the meantime, requesting that detailed breakdown from the state is probably the most important next step you can take.

I dealt with this exact same issue with my S-Corp last year and can definitely relate to the frustration of waiting for your accountant while trying to get your books in order! The good news is that you're asking the right question - the distinction between penalties and interest is crucial for proper tax reporting. As others have confirmed, the interest portion of your late payment charges IS deductible as a business expense on your S-Corp return, while the penalties are not. This follows the general tax principle that business interest is deductible, but government penalties are not. For your S-Corp, you'll report the deductible interest on Form 1120-S, Line 13 (Interest). The key is getting proper documentation from your state tax authority that clearly breaks down how much of your total payment was penalty versus interest - many notices lump these together, so you may need to call and request a detailed breakdown. A few practical tips from my experience: Keep detailed records of all payments and correspondence, make sure to deduct the interest in the year you actually paid it (not when the original tax was due), and consider setting up estimated quarterly payments going forward to avoid this situation recurring. Don't stress too much about this - it's a common issue and once you have the proper documentation, it's pretty straightforward to handle correctly on your return.