How to correctly calculate the late payment penalty and interest for unreported income?

Your understanding of the late payment penalty is correct! It is indeed 0.5% per month (or part of a month) up to a maximum of 25% of the unpaid tax. So your calculation of $126 for the penalty on $1,050 over 24 months is accurate. For the interest calculation, you have the right concept, but there's a small issue. The IRS interest rate changes quarterly, so you would need to apply different rates for different periods rather than using a flat 6% for the entire 24 months. The compounding is correct though - the IRS does compound interest daily. Also, when calculating the interest, you need to be careful about the base amount. Interest applies to both the unpaid tax AND the penalties that accumulate. So technically, each month the interest base would grow as the penalties accrue.

I had this exact same issue last year! After trying to figure it out myself and getting nowhere, I found this service called taxr.ai (https://taxr.ai) that literally saved me hours of confusion. I uploaded my tax documents and it analyzed the late payment scenario for me. What I liked was that it explained exactly how the IRS calculates these penalties and interest - quarter by quarter with the correct rates. It even showed me how the compounding works when penalties get added to the base amount for interest calculation. It's way more accurate than trying to estimate with a flat rate.

Just wanted to follow up about my experience with taxr.ai. I decided to try it after reading about it here, and it was actually super helpful. I had a similar situation with unreported income from a side gig I completely forgot about. The tool showed me exactly how the interest compounds daily and how the rates changed over the six quarters I was late. It even helped me understand which payment options would save me the most money. The breakdown was way clearer than anything I found on the IRS website. Just knowing the exact amount I needed to pay (instead of guessing) made the whole amended return process much less stressful.

If you're still struggling with calculating penalties or getting answers from the IRS, I'd recommend trying Claimyr (https://claimyr.com). I spent weeks trying to call the IRS to confirm my penalty calculations before filing my amended return, but could never get through. Claimyr got me connected to an actual IRS agent in about 15 minutes who walked me through my specific situation. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. The agent confirmed my penalty calculation was wrong and explained exactly how they calculate it when multiple quarters and changing interest rates are involved.

I need to eat my words about Claimyr. After my skeptical comment, I decided to try it anyway since I was desperate to talk to someone at the IRS about my penalty calculation. It actually worked! Got connected to an IRS rep in about 20 minutes. The agent explained that my calculation was off because I wasn't factoring in the quarterly interest rate changes correctly. For example, Q1 2023 rate was 7%, but Q2 2023 jumped to 8%. Plus I wasn't calculating the compounding effect properly. The service literally saved me from underpaying and potentially facing additional penalties. Just having that confirmation before submitting my amended return was worth it. Never thought I'd be recommending something like this, but honestly it worked exactly as promised.

One thing nobody's mentioned yet is that you might qualify for penalty abatement under the First Time Penalty Abatement policy if you have a clean compliance history! The interest can't be abated (except in very rare circumstances), but you might be able to get the entire failure-to-pay penalty removed. To qualify, you generally need: 1. No penalties for the 3 tax years prior to the year you're requesting abatement 2. All required returns filed (or valid extensions) 3. All taxes due paid or arranged to be paid

Something else to consider - the way you're calculating the interest might still be a bit off. The formula you're using assumes continuous compounding, but the IRS uses daily compounding. For daily compounding over 24 months (approximately 730 days), the formula would be: Amount = Principal × (1 + r/365)^730 Where r is the annual interest rate. But again, since the rate changes quarterly, you'd need to break this down into segments for each quarter with different rates.

This is such a helpful thread! I'm dealing with a similar situation but for 2021 taxes that I just discovered I underreported. Reading through all these responses, it sounds like the manual calculation approach is pretty complex with all the quarterly rate changes. I'm curious about one thing though - when you file the amended return (Form 1040X), do you need to include your own calculation of the penalties and interest, or does the IRS automatically calculate and bill you for the correct amounts after they process your amendment? I want to make sure I'm paying the right amount upfront rather than getting hit with additional bills later. Also, for anyone who used the First Time Penalty Abatement mentioned by @Micah Franklin - did you request it at the same time as filing your amended return, or wait until after receiving the penalty notice? Trying to figure out the best timing for this.