Unfiled Tax Returns: Consequences and Compliance

Consequences of Not Filing Your Tax ReturnsMost taxpayers are required to file a tax return each year; however, some have neglected to do so and find themselves overwhelmed with the task of catching up.  Reasons abound to justify a decision not to file including a fear that you will owe more than you can afford to pay, a belief that you wouldn’t owe enough to warrant filing, a hope that you will get to it the following year.  After reading this article, taxpayers should be inclined to jettison any such excuses or rationales in favor of filing compliance.

In recent years, the Internal Revenue Service has increased its focus on taxpayers with delinquent returns in an effort to improve compliance and compel the payment of tax due.  Now more than ever, taxpayers need to understand the costs, risks and disadvantages associated with forgoing required filings as well as how to remedy such a predicament.

This article explores the consequences of failing to file your tax return on time and identifies the steps you can take to get in compliance while also protecting yourself from IRS enforcement action and minimizing your exposure to tax liability.

Consequences of Not Filing Your Tax Returns

There are numerous unwanted consequences for taxpayers who fail to file their tax returns by the due date including but not limited to civil penalties, IRS assessments also known as substitute for return, surrendered refunds, and, in some cases, criminal liability.

Failure to File Penalty

The IRS will assess assess a failure to file penalty on the first day your tax return is considered late.  The penalty is based on how late you file your tax return and how much you owe.  It is equal to 5% of the unpaid taxes for each month or part of the month that a return is late.   However, it is capped at $25,000.

If the failure to file is deemed to be fraudulent, the penalty is increased from 5% to 15% for each month or part of a month that the return is late, and the penalty maximum penalty is increased from 25% to 75% of the unpaid taxes. The IRS must provide clear and convincing evidence that the taxpayer failed to file a tax return with the intent to evade taxes.

As if that is not enough, the IRS also charges interest on the failure to file penalties as well.  The date from which it begins to charge interest varies based on the type of penalty.

We note that you can request an extension of time to file your tax return.  The request must be filed by the tax return’s original due date and typically grants an additional six months to file.  As long as you file by the extension deadline, you will not incur a failure to file penalty.  However, you may incur a failure to pay penalty if you owe tax for that year and did not pay it by the April 15 deadline.

Substitute for Return Assessment  

If you fail to file your tax return voluntarily by the due date, the IRS may file one for you, also known as a substitute for return (SFR).  It prepares the return based on information it has received from your employers, banks and other payors.  This typically involves an overstatement of tax as the SFR will not include any exemptions, credits, or deductions you might otherwise be entitled to.  Filing your own tax return following an SFR almost always has the effect of reducing your overall tax liability.

The IRS starts the SFR process by sending you a letter which advises that it has not received the tax forms for the applicable year(s) and proposes an amount of tax (plus interest and penalties) based on the income you earned during the tax period.  You will then have thirty (30) days to: i) file your tax return, ii) agree to the assessment and collection of tax as stated in the letter or iii) explain via return correspondence why you do not need to file a tax return for the tax period in quest.

If you fail to respond within the thirty (30) days, the IRS will send a Notice of Deficiency also known as a “90 Day Letter” expressing the IRS’ intention to proceed with assessing the tax asserted unless you petition the U.S. Tax Court within ninety (90) days.  If you don’t respond to the Notice of Deficiency within the required timeframe, the substitute for return tax will get formally assessed against you and the IRS will commence collection.   Collection action can include the filing of a tax lien (public notice) and/or the pursuit of a tax levy (property seizure).

In short, you will want to quickly file your own tax return to correct an overstated substitute for return tax balance.

Held and Surrendered Refunds

If you are due a refund but have not filed a tax return for one or more years, the IRS may hold onto your refund for the current year.  That refund will be held until you either file your delinquent returns or provide an acceptable reason for not filing.

You also risk losing your refund if you don’t file your tax return.  If you are due a refund (e.g., from withholding or making quarterly estimated tax payments), you must file a return to claim it within 3 years of the filing due date.  The same rule applies to the right to claim tax credits, such as Earned Income Credit.

Diminished Social Security Benefits

If you are self-employed and do not file your federal income tax return, the self-employment income you earned will not be reported to the Social Security Administration and you will not receive credits for Social Security retirement benefits or disability benefits.

Criminal Liability

If you repeatedly do not file your tax returns you could theoretically be subject to criminal prosecution.  Technically, it is a misdemeanor to willful fail to timely file a federal tax return and it is a felony to commit tax evasion.  However, it is unlikely that the IRS will consider criminal action for unfiled tax returns.  Nearly 10% of the taxpaying population has unfiled tax returns.  Possible nonfliers who might be subject to criminal liability would be those with extremely high income or income from illegal sources.

Steps to Get Filing Compliant

Based on the foregoing list of consequences for failure to file, taxpayers should be incentivized to file tax returns timely, even if they cannot pay the tax that they owe.

If you haven’t filed in several years, you may not need to go back more than six years and you may not need to file for every year.  It is advisable to contact the IRS and review your IRS account transcripts to determine fling compliance requirements and evaluate whether the IRS has already filed a substitute for return for any year(s).  A tax attorney can do this for you.

Once you know what years you need to file, it is advisable to obtain your IRS wage and income transcripts for each applicable year.  These transcripts show all income that was reported to the IRS under your social security number for the years requested.  A tax attorney can obtain the wage and income transcripts for you.  Your tax preparer will need this information when preparing your delinquent tax returns.

Have your tax attorney contact the IRS to request that all collection activity be suspended while you are preparing your tax returns so that you are protected from IRS enforcement action in the interim. they suspend collection activity to protect you from any enforcement action while you have your tax returns prepared.

If you owe tax as a result of filing tax returns for several years, a tax attorney can help you reduce the outstanding liability and set up an affordable resolution.

Do You Need a Tax Attorney?

A competent tax attorney can help you get filing compliant while protecting you from IRS enforcement action in the process.  They can also help you minimize your tax liability and get your past due accounts in resolution status.

The experienced tax attorneys at Segal, Cohen & Landis have helped hundreds of clients become filing compliant while also protecting them from IRS enforcement action and optimally resolving outstanding liabilities via a variety of services including:

If you are interested in having a complimentary consultation with one of our partner attorneys regarding your tax matter, please feel free to contact us at 866-505-1872.  We would be happy to speak with you and will advise you how we can resolve your case and how much it would cost.