When you miss a tax deadline, the IRS can charge two separate penalties: one if you don’t file your tax return and another if you don’t pay what you owe.
You may be able to avoid or minimize these penalties, but ignoring your tax filing obligations isn’t usually an option. Here are the penalties that could be in store and ways to reduce them.
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Generally, the IRS charges a failure-to-file penalty on tax returns filed after the due date or the extended due date, unless there’s a reasonable cause for late filing. Typically the deadline is April 15, but this year it’s April 18. The penalty is based on the amount of unpaid taxes and how late you file your return.
The IRS’s failure-to-file penalty is 5% of your unpaid taxes for each month or partial month your tax return is late. But it’s capped at 25% of your unpaid taxes.
What Is the Late Payment Penalty?
Another penalty applies when you don’t pay the total tax bill you owe by the due date. The failure-to-pay penalty is 0.5% of your unpaid taxes for each month or part of a month you don’t pay your tax bill. Like the failure-to-file penalty, the late payment penalty is capped at 25% of your unpaid taxes. The penalty won’t be charged if you can show reasonable cause.
If both the failure-to-file and failure-to-pay penalties apply, the IRS reduces your failure-to-file penalty by the amount of the failure-to-pay penalty.
For example, say you owe federal income taxes and didn’t file your return or pay the amount you owe. In month one, rather than assessing a 5% failure-to-file penalty plus a 0.5% failure-to-pay penalty, the IRS would apply a 4.5% late-filing penalty plus a 0.5% failure-to-pay penalty, for a combined total of 5%.
What If You Are Owed a Refund?
If you’re owed a tax refund, the IRS doesn’t charge a penalty for filing your tax return late. However, there are two excellent reasons for filing your return as soon as possible.
Claiming your refund. File your tax return too late, and you could forfeit a refund. By law, you have three years to file a return and claim a tax refund. That three-year window starts on the original due date of the return. For example, your 2021 tax return was due April 18, 2022. If you haven’t yet filed your return for the 2021 tax year, you have until April 18, 2025, to file and claim a refund.
Starting the clock on the statute of limitations. Generally, the IRS can audit tax returns filed within the past three years. This is known as the statute of limitations. However, there are some exceptions. If the IRS believes you’ve grossly understated your income—by 25% or more—it has an additional three years. The clock starts running when you file your return. So, if you filed your 2019 return on July 1, 2022, the IRS has until July 1, 2025, to audit your return—or July 1, 2028, if you grossly underreported your income. As long as you delay filing, that clock never starts—so the IRS can choose to audit you five, 10 or 15 years down the road.
How to Avoid a Failure-to-File Penalty
The best way to avoid a failure to file penalty is to file your return by the due date or request an automatic six-month extension. You can file a tax extension by mailing Form 4868 to the IRS or paying the tax you owe via Direct Pay, the Electronic Federal Tax Payment System (EFTPS) or credit or debit card by the tax due date. Most of the best tax software platforms can also electronically file an extension on your behalf.
If filing on time isn’t an option, file and pay the taxes due as soon as possible. Then look into penalty abatement.
Penalty abatement is the process of removing penalties for taxpayers who made a mistake or faced extenuating circumstances. There are two common reasons the IRS may consider penalty relief.
Reasonable cause. If you didn’t file on time due to extenuating circumstances, the IRS may agree to waive your penalties. Examples of reasonable causes include a house fire, natural disaster, serious illness or death of an immediate family member.
First-time penalty abatement. If you’re normally on top of your filing responsibilities but missed the deadline for one reason or another, the IRS may allow a first-time penalty abatement. To qualify, you must have filed all of your tax returns, paid the tax due or set up an installment agreement and have no prior penalties within the past three years.
To request penalty abatement, call the toll-free number on your IRS notice or submit your request in writing using Form 843. To have a penalty removed due to reasonable cause, you will also need to send the IRS copies of supporting documentation, such as hospital records, a letter from your doctor, a death certificate or insurance claim reports.
What To Do If You Can’t Afford To Pay Taxes
Being unable to pay your tax bill isn’t a reason to avoid filing a return, and it won’t help you avoid penalties.
Your best course of action is to file as soon as possible, then consider the following payment options.
Set up an IRS installment agreement. With an IRS installment agreement, you have up to six years to pay your tax liability. The IRS charges failure to pay penalties and interest during installment plans, but it reduces your penalty to 0.25% of your unpaid balance. You can apply for an installment agreement online, by calling 1-800-829-1040 or by submitting Form 9465.
Consider an ‘offer in compromise’. An offer in compromise allows you to settle your back taxes with the IRS for less than you owe. However, it’s typically only available to taxpayers experiencing severe financial difficulties. The IRS Offer in Compromise Pre-Qualifier tool can help you determine whether you may be eligible and calculate an offer amount. Filling out the application and negotiating your offer can be complex, so it’s best to get help from a tax professional with experience dealing with offer in compromise agreements.
Attain ‘currently not collectible’ status. If even a partial payment toward your tax bill is out of the question, you may qualify for “currently not collectible” (CNC) status. While your account is in CNC status, the IRS won’t try to collect from you by levying your assets or income. However, it will still assess additional penalties and interest and may keep future tax refunds and apply them to your tax debt. You can start the process of qualifying for CNC status by calling the IRS at 1-800-829-1040.
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What Happens If You Don’t File Your Taxes at All?
If you don’t file your return, the IRS may file one for you. This is known as a “substitute for return” (SFR).
Having the IRS file a return for you may sound convenient, but you’ll likely owe significantly more taxes than you would if you filed a return yourself. That’s because the IRS bases its SFR on your W-2s, 1099s and other available tax forms. Most of those forms have information about your income but not your deductions. So if you have business expenses, charitable donations, out-of-pocket medical expenses or other write-offs, the IRS won’t know about or include them.
Fortunately, if the IRS files an SFR and assesses tax, you’re not stuck paying the amount it says you owe. You can contest the bill by filing your delinquent return.
However, if the IRS files an SFR and you don’t respond, the IRS will start its collection process, which includes levying your wages or bank account and filing a federal tax lien on your property.
The penalties and interest on unpaid taxes can be substantial, which is why ignoring your tax filing obligations is never a good idea. If you owe back taxes, it’s wise to work with an experienced CPA or tax preparer to file past due returns, set up a reasonable payment plan and request penalty abatement.
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