Always File a Tax Return Even If You Can't Pay Taxes Due

Find out why you are better off with a failure-to-pay penalty than the other consequences you face for failing to file your tax return.

Your federal income tax return is due on April 15. You can get an automatic extension to delay the due date until October 15 by filing IRS 4868 (but this does not extend the April 15 due date for paying all taxes you owe). What happens if you fail to file a tax return this year? You won’t get arrested. The IRS doesn’t have any tax police out looking for nonfilers. But, eventually, bad things will happen, and get worse over time.

Sooner or later, the IRS will probably discover you should have filed a return. This usually happens because third parties reported to the IRS payments they made to you. This could be salary an employer reports on Form W-2, income you earned as an independent contractor reported by your clients on Form 1099-MISC, or interest income reported by a bank or other financial institution on Form 1099-INT. IRS computers will check and see if this income has been reported by you on your timely filed tax return. If there is no return on file, the IRS will send you a notice called Notice CP 59, First Notice Request for Your Tax Return, demanding that you file a tax return and pay any tax due.

If you still fail to file, the IRS may file a substitute return for you. When it does this, it calculates your income tax for you, with you filing as a single individual with one exemption. Obviously, this substitute return may not give you credit for deductions and exemptions you could be entitled to receive. The IRS will also send you a Notice of Deficiency CP3219N (90-day letter) proposing a tax assessment. You will then have 90 days to file your past due tax return or file a petition in Tax Court. If you do neither, the IRS will proceed with the proposed assessment. If you don’t pay the assessment, the IRS can use various method to collect it, including a levy on your wages or bank account, or filing a federal tax lien which will make it impossible for you to sell real property without first paying off the lien.

In addition to the taxes you should have paid, you’ll owe interest and penalties. The penalties for not filing a return are severe: 5% per month on the amount you owe, to a maximum of 25% reached after five months. This is in addition to the interest the IRS charges for paying your taxes late--the interest rate is about 3%. If you have unpaid taxes due, you’ll also have to pay a failure-to-pay penalty of 0.5% of your unpaid taxes for each month the taxes are not paid. This penalty can be as much as 25% of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5% failure-to-file penalty is reduced by the amount of the failure-to-pay penalty.

Having to pay penalties and interest is no fun. But the ill effects of not filing a return don’t stop there. For example, if you are self-employed and do not file your federal income tax return, any self-employment income you earned will not be reported to the Social Security Administration and you will not receive credits toward Social Security retirement or disability benefits. Being a nonfiler is also not good for your credit rating and could make it difficult or impossible to obtain a loan. Home lenders usually want copies of your filed tax returns when you apply for a loan.

The moral: No matter what, you should file a tax return by the due date, which you can automatically extend to October 15 by filing IRS Form 4868. This is true even if you can’t pay all the taxes you owe by the April 15 deadline. The failure-to-file penalty is usually more than the failure-to-pay penalty. So even if you can’t pay all the taxes you owe, you’ll be much better off if you file your tax return on time and pay as much as you can.

The IRS will work with you to help you pay your taxes over time. Depending on your financial circumstances, it may even accept less than what you owe as full payment. For details, see the article “What If You Can’t Pay Your Taxes.”

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