Late Tax Return? Should I file it if it if I can't afford to pay the balance?
Choosing to leave a tax return unfiled because you can't afford to pay the debt associated with it, is a mistake. For some, just a small one. For others…a big one.
There are a few important reasons why this is true. The most common that I see are as follows:
1. Failure to file penalty
Not only can the IRS assess a civil penalty for the failure to pay the tax debt but it can also assess one for a failure to file. This penalty is calculated based on the time from the deadline to file your tax return (including extensions) to the date you actually filed it. It is 5% for each month the return is late, up to a total of 25%. This percentage is based on the amount of the tax due as it is shown on the tax return. So..if the amount you owe is quite high, the penalty will be as well. Filing it on time avoids the penalty entirely.
2. Criminal Failure to File
Failing to file a tax return on time is a crime. However, it is the IRS' internal policy not to recommend prosecution for failure to file if the return is voluntarily filed or arrangements are made to file before the taxpayer is notified of a criminal investigation. The vast majority of people with late tax returns are not prosecuted but this is probably true because the eventually file and do so before the IRS begins the criminal investigation.
3. Substitute Returns
The IRS will commonly do a tax return for a non filer. When it does this, it doesn't do the return correctly. No credit for deductions and exemptions etc. These returns almost always overstate the debt. They are always used as a basis for the filing of the notice of tax lien and to start the collection process. They can be fixed but it is often much more difficult to fix them years after the fact. There are circumstances where an old substitute shouldn't be replaced by a correct return. It is wise to get advice before every corrected return is filed.
4. Lose ability to bankrupt debt
If a substitute tax return is assessed – the debt associated with that tax year whether based on that return or the taxpayer's later filed correct return is likely never going to be considered dischargeable in a bankruptcy. This is often a very bad result, as bankruptcy can be the best way for many to remove the debt and get a fresh start.
5. Lost Refunds
If you are owed a tax refund and you wait more than three years from the date the return is due to file the return, you will lose the refund. This applies to the earned income tax credit as well. I have seen taxpayers lose tens of thousands of dollars as a result.