I Cannot Pay the Tax Reported on my Tax Return. Should I file?

In short, the answer is YES!

In order to understand why you must file, it is important to grasp the penalties associated with failing to timely file.

IRS Failure to File Tax Return Penalty

The IRS’s failure to file penalty runs at 5% per month, up to a maximum of 25%, or fraction of month that the return is filed after its due date. Accordingly, if the penalty maxes out, you will owe an additional 25% of the tax due.

In addition, the IRS will tack on a fee of the lesser of $135.00 or the amount of tax due.

For example, if a taxpayer owes $100,000.00 and the penalty maxes out, the taxpayer will owe an additional $25,135.00. To make matters worse, interest accrues not only on tax, but also on the penalty. This causes an IRS tax problem to spiral out of control.

The failure to file penalty is reduced by the failure to pay penalty, example below, when the two penalties run concurrently.

Most importantly, the failure to file can lead to serious non-monetary consequences. The failure to file is a misdemeanor punishable up to one year in jail as well as a fine of not more than $25,000 ($100,000 in the case of a corporation). Even worse, a taxpayer who fails to file returns for multiple years commits a separate misdemeanor offense for each year.

The IRS Failure to Pay Tax Penalty is Not an Extension to Pay

An extension of time to file is not an extension to pay taxes owed. Therefore, if you owe tax it must be paid in full by the due date excluding extensions. If you do not timely pay the tax in full, the Internal Revenue Code imposes a penalty of 0.5% per month, up to a maximum of 25%, for late payment.

For example, if the due date for a tax year is April 15 and you file a valid extension, the return will be due on October 15; however, if you owe money, you will be subject to the failure to pay penalty which is assessed on April 15, the due date.

The failure to pay penalty increases to 1% per month if the taxpayer does not pay within 10 days of a notice of intent to levy. The amount of unpaid tax subject to the penalty is reduced by the amount of any tax which is paid on or before the beginning of a month.

Interest on the failure to pay penalty begins to accrue if the taxpayer receives notice and does not pay.

If you negotiate an IRS Installment Agreement, the 0.5% penalty is reduced to 0.25%. This reduction is allowed only if you filed a timely return.

Application of IRS Failure to File and Failure to Pay Penalty

Below is an example of how the failure to file and pay penalties would be assessed if the applicable federal interest rates vary between 3% and 4%.

Example

On April 15, 2011, Taxpayer does not file an extension and owes $100,000.00 of tax. On November 2, 2011, Taxpayer would be subject to the following penalties:

Failure to File: $22,500.00

Please note, the failure to file penalty, $25,000.00 (5 months late), is offset by the failure to pay penalty of $2,500.00 (5 months late) to derive at $22,500.00.

Failure to Pay Penalty: $3,500.00 (7 months late at .5% rate)

Interest: $2,227.06 (Interest rates of 3% to 4%)

Penalty Interest: $501.09 (Interest rates of 3% to 4% based on the Failure to File Penalty)

Total: $128,728.15 (includes the minimum failure to file penalty which is $135.00)

In the same example, let’s assume you filed a tax return:

Failure to File Penalty: $0.00

Failure to Pay Penalty: $3,500.00

Interest: $2,227.06

Penalty Interest: $0.00 (example assumes IRS did not send the Taxpayer notice)

Tax Savings: $23,000.00

Conclusion

While it is true it may take the IRS longer to find you if you do not file a tax return, you will save yourself money and avoid any potential, although rare, criminal exposure. With both penalties maxing out, the taxpayer faces an additional 50% of tax plus interest. Therefore, if you owe tax, it is essential you timely file your tax return.

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