How to Handle Late Tax Returns

Every year, about 7 million taxpayers miss tax deadline or fail to file their tax returns according to data from the Internal Revenue Service. This figure constitutes roughly 5 percent of the taxpayer base in the U.S., resulting in government revenue losses of up to $28 billion annually. The IRS has a system that red flags tax cheats whether they are stop-filers, non-filers and under-filers.

Failure to File vs. Failure to Pay
“Stop Filer” is a term applied to taxpayers that consistently comply with tax filing requirements and then suddenly stop filing their returns. If your employer or client reports your income to the IRS on a 1099 or a W-2, the IRS will flag your information as a non-filer because they have access to tax forms that cannot be matched to tax returns. Understating your income, consciously or unintentionally, could result in a lower tax liability but make you liable for IRS penalties.

Failure to file means not filing the returns within the given time frame while failure to pay means filing the required paperwork but not turning in the full amount of tax obligation by the tax filing deadline. To force compliance with tax laws, the IRS is allowed to prepare a “substitute return” on behalf of those who failed to file, using data that was submitted by employers and applying customary exemptions and deductions. Substitute returns will always show a much higher liability than actual returns you have prepared and filed because substitute returns which are prepared by the IRS will not take into account your business expenses, basis in assets sold, itemized deductions, proper marital status, dependents and many tax credits.

Essentially, filing federal taxes late is better than not filing even if you cannot pay the tax dues at the time of submission. Penalties will still accrue for all unpaid tax obligations effective on the day after it is due until fully paid but by filing your tax return timely you avoid a late-filing penalty.

Why Taxpayers should File Late Returns Now
There are important reasons why you should file your returns even if it is long past due. For one, penalties will continue to add up on any payments due. Also, if you are owed a refund due to exemptions, deductions and tax withheld, you only have three years from the original due date to claim the refund (and in certain cases this limitation is two years). When this period expires, you forfeit your refund to the IRS. Additionally, you would not be able to claim tax refunds for later years unless returns for the missing years are filed.

Loan applications, lease qualifications, scholarship applications and similar events require submission of tax returns from the previous years. Failure to present these documents that are used as proof of income may disqualify your application from moving forward. For self-employed taxpayers, filing a tax return is the only way that your credits for Social Security benefits can be reported and tracked. If you don’t comply with tax filing requirements, you would not build up enough retirement or disability credits.

Failure to respond and comply with an IRS tax bill will trigger the collection process, which may include tactics such as wage garnishment, an asset freeze or a federal tax lien.

IRS Penalties for Late Filing
To reiterate, the IRS assesses two different penalties for filing federal taxes late. The failure to file penalty is assessed at 5 percent for each month that the returns are late and is capped at 25 percent. Assessments for failure to pay are 0.5 percent monthly for a maximum of 25 percent. If both penalties apply, the total amount is capped at 5 percent per month for a late tax return. If you qualify for a refund during the tax year in question, and you have not forfeited the refund, you may not be charged with penalties for taxes owed on a delinquent tax return.

What to do when you Miss Tax Deadline
Starting with your 2016 tax return, if you will be unable to prepare your tax returns within the original deadline, file for an extension using the Form 4868, application for automatic extension of time to file U.S. individual income tax return on or before the deadline to file your Form 1040. If you did not do this for your 2015 tax return, your return now is delinquent and you will be subject to a late-filing penalty. Where an extension was timely filed, penalties for failure to file will not apply, but penalties will still be assessed on the balance due. With Form 4868, the revised deadline will be reset by about five months.

Navigating the Late Filing Process
Whatever the reasons for non-filing, it is important to comply with the tax filing requirements sooner rather than later. Start the process by putting the paperwork together, including IRS Form W-2, all 1099 forms and other proof of income for the year or years that require filing a late tax return. Organize receipts, expense ledgers, donation receipts and other proof of expenses and deductions. If you have the ability to generate an IRS form 1040 or 1040-EZ, do so.

Retaining the services of a tax practitioner is useful when you do not have copies of the W-2s or 1099s for the year in question. Your tax practitioner can assess this information directly from IRS. Also, as it may be more difficult to assess software to prepare returns from older years, enlisting the services of a tax practitioner can be very helpful in getting all of the delinquent tax returns completely quickly.

If you cannot meet your tax obligations on delinquent returns, your tax practitioner can help you explore your payment options such as scheduled monthly payments through an IRS-approved installment agreement. Another option is called an Offer In Compromise where you will pay less than what you actually owe. As there are different types of payment plans and the IRS does make it difficult for taxpayers to settle their liabilities at a discount, it is best that you seek guidance from a tax practitioner to make sure you are pursuing the best option for your case.

Prosecution for Non-compliance with Tax Laws
Criminal fraud refers to outright tax evasion. Penalties for tax evaders include hefty fines, imprisonment or both. Civil fraud charges applies to underpayment without intent to completely evade making tax payments. The penalty imposed may be as much as 75 percent of the portion of the underpayment. Negligence refers to inadvertent underpayment, and the penalty is 20 percent of the underpayment that is due to negligence. A frivolous return is one that intentionally excludes information that is crucial to processing the returns, and the penalty is $500 for each frivolous return.

Filing federal taxes late is a complicated matter. Consult a tax practitioner to help you find the best option to file and pay for delinquent returns.