Consequences of Unfiled Federal Income Tax Returns

unfiled tax consequencesWhen April 15th rolls around, the IRS expects your return to be filed and any taxes owed to be paid promptly. Requesting an extension can push back the deadline a few more months but it doesn’t delay the inevitable. At some point, you’ll have to face the music and the longer you wait to file, the more serious the consequences may become. Even if you don’t owe any taxes, it’s still to your advantage to get your return in as quickly as possible. Here’s a look at what can happen if you don’t take action.

Penalties and Interest Begin Adding Up

The most immediate consequence of not filing a tax return is you’ll get hit with penalties and interest. There are two separate penalties that may apply if you owe taxes:

  • Failure-to-file penalty – If you don’t file a return by the filing deadline, you’re automatically subject to a late penalty equal to 5 percent of the total tax due. The penalty is tacked on for every month or partial month you don’t file and can eventually grow to 25 percent.
  • Failure-to-pay penalty – A penalty of 0.5 percent of the balance owed also applies when outstanding taxes are not paid. When both penalties are due, the failure to file penalty is reduced to 4.5 percent. The IRS will knock the failure to pay penalty down to 0.25 percent for taxpayers who resolve their tax debt through a monthly payment plan.

As an added incentive to get taxpayers to file on time, the IRS also charges interest on unpaid taxes. The interest is tied to the federal short-term rate and it’s adjusted quarterly but it’s not uncommon for it be anywhere from 3 to 10 percent. While you may be able to have penalties abated, you can’t get the amount of interest you owe reduced.

Loss of Refund and Other Tax Benefits

If you’ve got a refund coming to you, there’s no real penalty for not filing your return on time but you can’t afford to put it off forever. There’s a three-year statute of limitations on filing returns to claim a refund and if you don’t get yours in on time, any money that’s owed to you is forfeited to the government.

The three-year limit also applies if you’re planning to claim certain tax credits, such as the Earned Income Tax Credit. You can’t retroactively claim the credit in later tax years so if you don’t file a return, you lose out. Finally, if you’re self-employed and don’t file a return, you won’t get any credit towards your Social Security retirement or disability benefits.

Substitute Return May Be Filed

In some cases, the IRS may decide to file a substitute return on your behalf using your W2s or 1099 forms. While it may seem easier to let Uncle Sam do all the hard work for you, it could end costing you even more in the long run. When a substitute return is filed, you only get one exemption and the standard deduction is applied. That means that even if you have dependents, a substantial amount of itemized expenses or you qualify for tax credits, none of it counts in your favor and your tax liability could be greatly overstated.

Once the substitute return is complete, the IRS will send out a Notice of Deficiency with a proposed tax assessment. You’ll then have 90 days to submit your return or file a petition with the Tax Court. If you don’t follow through on either option, then you’re on the hook for whatever amount the IRS has determined you owe, along with any interest and penalties you’ve racked up in the meantime.

Enforcement of Collection Efforts

If the IRS files a substitute return and delivers an assessment, collection actions may not be far behind. Depending on how much you owe and the circumstances surrounding your failure to file, enforcement can take several forms:

  • Tax levyA tax levy is a seizure of your assets. Typically, levies take the form of a wage or bank account garnishment, although your personal property such as a home or vehicles, can also be seized. In the case of a bank account or wage garnishment, certain monies, including SSI or disability benefits and child support payments received are exempt.
  • Tax lien – The IRS may also decide to place a lien against your property. The only way to get rid of the lien is to pay off your tax debt or sell the property, in which case any proceeds are paid to the lienholder. Having a lien against you also damages your credit, which can make it difficult to apply for new loans or lines of credit.
  • Criminal prosecution – While unpaid taxes are usually a civil matter, the IRS can turn it into a criminal case if they believe you willfully tried to avoid paying. Failing to file a return is technically a misdemeanor, punishable by a minimum $25,000 fine and up to one year in jail. At the other end of the spectrum is tax evasion, which can land you up to five years in prison and a penalty of up to $100,000.

As you can see, waiting until you reach the point of enforcement to deal with an unfiled return only makes cleaning up the mess that much more difficult. The IRS has several solutions that can help you to resolve the situation, the option that is best for you is determined by tax, financial and sometimes your personal situation.

Consulting a knowledgeable tax professional can help you determine which option is right for you.