Every year we are asked this question, usually in March and April. People continue to struggle with foreclosures, layoffs and the sluggish economy. Unfortunately, many who can’t afford to pay their taxes simply stop filing. That is probably the worst thing one can do.
Willful failure to file a tax return is a crime punishable by prison. Although few people are prosecuted, failing to file in any given year is a very slippery slope for some. Optimistic taxpayers believe that they can catch up and elect not to file this year and then simply catch up in the following year. Only next year some other financial hardship occurs and soon no return has been filed in years. That does get the attention of the IRS.
Assuming the risk for prosecution is small, there are still many good reasons to file a return even if you can’t afford to pay the taxes.
The IRS adds a failure to file penalty of 5% per month for each month the return is late. The maximum failure to file penalty is 25% and that can be reached fairly quickly.
Often the IRS will file a substitute tax return on the taxpayer’s behalf. The IRS considers every 1099 and W2 as income but frequently allows no expenses or exemptions. The tax liability on substitute returns is almost always higher than would actually be owed if a real return were filed.
The IRS can also start the enforced collection process. This includes seizure of bank accounts, property liens and the further demise of one’s credit score.
Filing a return without payment still will trigger penalties but those penalties are usually much lower than those assessed on those who fail to file and pay.
There are attractive options for those who file but simply can’t pay.
If you can pay the debt within 120 days, the IRS will almost always grant a short-term extension of time to pay. In certain cases, the IRS will automatically approve installment agreements of up to three (3) years for those with a good compliance record and relatively small tax debts.
Many people elect to borrow money and pay the IRS in full. Although bank loan rates may be steep, those interest rates are usually much lower than the interest and penalty on unpaid taxes.
Another popular option is seeking an offer in compromise. Nearing retirement? Questionable debt? Depleted assets? Disabled? The rules for offers just became more generous. Although you can represent yourself before the IRS, having a good accountant or lawyer is important if seeking to compromise your debt. Whether you hire a professional or do it yourself, don’t waste your money on those that advertise on late night TV to settle your tax debt for pennies on the dollar.