One of the most common refrains I hear from taxpayers who’ve failed to file returns for a number of years is that they prepared their return one year, saw they couldn’t afford to pay the taxes shown as owing on the return and elected to not file the return in the hopes of buying time to come up with the money to pay the bill. Then the next year, they don’t prepare a return because they still haven’t filed or paid the taxes for the previous year. And so one year of unfiled returns becomes two, which becomes five, and so on. While failing to file a return showing a balance due may buy you a couple more years off the IRS collections radar, the IRS will almost always catch up with you eventually, and when they do, you’ll have wished you’d filed your return on time, regardless of your ability to pay the balance due.
Being Unable to Pay Federal Income Tax Is Not a Crime; Willfully Failing to File a Tax Return Is:
§7203 of the Internal Revenue Code makes it a criminal offense for any person, required to pay a tax or file a return, to willfully fail to do so. The operative word here is “willfully.” In this instance, as in most instances of the term’s use in the context of the IRC, willfulness means “a voluntary, intentional violation of a known legal duty.” Therefore, if you are truly unable to pay your taxes, you have not met the thresholds under IRC §7203. In the United States, the principle that one should not be imprisoned for a lack of the ability to repay their debts dates back to at least 1839, when Martin Van Buren signed a congressional act banning imprisonment for debt in states that had already abolished the same.
In keeping with this principle, the IRS Tax Crimes Handbook recites, “There is a strict necessity as a part of showing willfulness to establish an ability to pay, thereby avoiding imprisonment for debt.” Though, as the Tax Crimes Handbook points out, “A claim that the taxpayer lacks liquid assets to pay the tax where the taxpayer has been living high and spending freely will not prevent a showing of willfulness.” In practice, so long as you’re willing to work with the IRS to come to an agreement to repay what you can, you’re not ask risk of criminal penalties for failing to pay your taxes, and if a financial disclosure demonstrates that you cannot afford to pay anything towards your taxes without creating a financial hardship, the IRS will place your balance in Currently Not Collectbile status until your financial situation improves or the liability is written off.
However, choosing to not file a return is against the law. And a lack of funds is not a legal excuse for failure to file returns. Ripperger v. United States, 248 F.2d 944 (4th Cir. 1957). So, at a bare minimum, ensuring your return is filed even though you’re unable to pay the balance due will afford you protection from possible criminal charges related to your failure to file a return. In the vast, vast majority of instances of non-filing taxpayers, the IRS will not pursue criminal charges, but that doesn’t mean doesn’t that failing to file your return won’t cost you; it will, and the penalties can be steep.
Failure-to-Pay Penalties vs. Failure-to-File Penalties:
The penalty for failure to file your return by the due date (including extensions) is 5% of the unpaid taxes for each month or part of a month that a tax return is late, up to a maximum of 25%. By contrast, the penalty for failing to pay your taxes by the due date (generally April 15th, regardless of an extension of time to file), is .5% of the unpaid tax per month, up to 25%. However, when subjected to both the failure-to-file and failure-to-pay penalties simultaneously (which is most-often the case), the late filing penalty is reduced to 4.5% per month, bringing the combined FTP and FTF penalties to 4.5% per month. Even so, it’s clear that the failure-to-file penalty will accrue and cap out much quicker than the failure to pay penalty. Say, for example, you prepare a tax return and it shows that you owe $100,000 in taxes. Knowing that you can’t afford to cut a $100,000 check to the IRS, you elect not to file your return. Six months later, you receive an inheritance from a late relative and are now able to pay the taxes in full, so you file your return. Unfortunately, the failure to file your return by the due date will cost you an additional $25,000 in failure-to-file penalties alone, while the failure-to-pay penalty would be only around $3,000. In addition, once a tax debt is covered by an installment agreement with the IRS, the failure-to-pay penalty accrual rate is typically cut in half, down to .25% per month.
The Time Limitation for the IRS to Audit a Return Doesn’t Begin to Run Until a Return is Filed:
Another reason to always file your return, even with a balance owing, is that by filing the return the clock starts running on how long the IRS has to audit a return. Generally speaking, the IRS has 3 years from the date a return is filed. Until a return is filed, this 3 year window does not begin to run. Now, this isn’t a huge deal when you’re dealing with just one unfiled return, however, if you go a number of years without filing returns, when you do go to file the delinquent returns, all of the returns filed will have approximately the same 3 year window for the IRS to select them for examination. When the IRS selects a return for examination, they will typically review a couple returns for other years to see whether an issue that is present for the year under examination is also present in returns for other years. If they find similar issues in other years, they have no problem expanding the scope of the audit to any open years where they think they may be able to make additional assessments. When returns are filed timely, the IRS can generally only expand the audit to include three years of returns. If however, you file 3 delinquent returns at the same time, if the IRS selects your returns for examination, they now have potentially 6 years of returns to pull into the examination.
Not only that, but if items of income have been reported to the IRS via forms 1099, W2, etc., eventually the IRS might prepare a Substitute For Return, or SFR, and make an assessment against you anyway in the absence of a final return. While an original return can generally always be filed to replace a SFR, an SFR will generally overstate your tax liability, as it will always elect a Single or Married Filing Separately filing status, the standard deduction, and may not include basis in stock sales that were not reported to the IRS, thereby overstating your capital gains. Furthermore, tax liabilities arising from Substitute For Returns are usually not dischargeable in bankruptcy, even if an original return is filed later. In addition, taxes cannot be discharged in Chapter 7 bankruptcy until at least 2 years from the date the return is actually filed. Therefore, if you think Chapter 7 bankruptcy may be necessary in the future to deal with the tax liability, you should always file an original return by the due date.
---If you’re hesitant to file a return and generate a balance owing, or have gone a number of years without filing a return, please contact us. We can assist you get back into filing compliance and work with the IRS on your behalf to enter into a collection alternative that will allow you to satisfy any tax owing in a way that works for you.