Should I File My Taxes, if I Cannot Pay?

You know you cannot afford to pay your tax bill this year. Things just got away from you and the filing deadline, usually April 15th, is creeping closer and closer. Some taxpayers find themselves wanting to ignore the dreaded news of how much they owe, wishing it would disappear. Unfortunately, the IRS will not go away. What is even worse, is the IRS may take one or two years to contact you regarding an unfiled tax return or underpayment. However, penalties and interest during that time continue to accumulate from the date the tax return and payment was due -- typically, April 15th. Even if you cannot pay your taxes, you should file your tax return. Here’s why.

Penalties

There are two main penalties that apply when taxpayers do not file their tax returns on time and pay the amount of tax due: failure-to-file penalty and failure-to-pay penalty. The failure-to-file penalty, which the IRS applies to taxpayers who do not file their tax returns, generally is higher and maxes out quicker than the failure-to-pay penalty. What is worse is if both apply, the IRS will charge both of them simultaneously. However, the IRS does cut you a small break by not charging more than 5% of the unpaid taxes per month (or part of a month) for both of the penalties, if they both apply to the same month.

Failure-to-File Penalty

The failure-to-file penalty applies to taxpayers, who do not file their taxes or file an extension by the deadline, typically April 15th unless the due date falls on a weekend or holiday. Normally, the penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late. The penalty starts accumulating the day after the taxes are due, usually April 16th, and maxes out at 25%. If you fail to file your taxes more than 60 days after the due date, you will be charged a minimum of the lesser amount of either $135 or 100% of the unpaid tax.

Example. When John files his tax return in November, he owes $1,000 in federal taxes. He did not file an extension, and his tax return was due on April 15th. This means John would owe $50 ($1,000 amount of taxes owed x 5% failure-to-file penalty) for each month or part of the month he failed to file his taxes. Since John filed his tax return in November, he would owe the penalty for eight months (April - November). However, the penalty could be maxed out in as little as 5 months. Since John did not file his return until eight months after the due date, he would max out the failure-to-file penalty at $250 or 25% of the unpaid tax amount of $1,000. Now, John owes the $1,000 for federal income taxes and $250 failure-to-file penalty for a total of $1,250.

John could have avoided this penalty easily by filing his tax return by the due date. Also, John could have avoided the penalty by filing an extension and filing his tax return before the extended due date. Filing an extension gives taxpayers an additional six months to file, usually until October 15th. The failure-to-file penalty only applies if you fail to file your tax return by the due date or extended due date, if you applied for a tax extension.

Failure-to-pay

The failure-to-pay penalty applies to taxpayers who do not pay their taxes by the deadline, typically April 15th unless the due date falls on a weekend or holiday. Normally, the penalty is ½ of 1% of the unpaid taxes for each month or part of a month that your payment is late. The penalty starts accumulating the day after the taxes are due, usually April 16th, and maxes out at 25%.

Example. In the example above, in addition to the $250 failure-to-file penalty, John would owe about $5 ($1,000 amount of taxes owed x ½% failure-to-pay penalty) for the failure-to-pay penalty for each month or part of a month, he failed to pay his taxes or approximately $40 ($5 monthly failure-to-pay penalty x 8 months).  

John could have avoided this penalty by paying his taxes by the due date, typically April 15th. Also, John could have avoided the penalty by filing an extension and paying at least 90% or more of the balance due by the due date, usually April 15th. Filing an extension gives taxpayers an additional six months to file, usually until October 15th; however, it does not give taxpayers additional time to pay.

The failure-to-pay penalty only applies if you fail to pay your taxes by the due date. If you set up an installment agreement, the IRS will cut the failure-to-pay penalty in half, dropping it to ¼ of 1%.

The Bottom Line

As you can see, the failure-to-file penalty is higher and accumulates much faster than the failure-to-pay penalty. Although if you wait too long to file and pay your taxes, both penalties will max out at 25% of the unpaid tax. In some cases, taxpayers do not file because they are afraid they owe, only to find out they are due a refund.

Do not delay filing your taxes any longer. Even if you owe taxes, it is better to file your taxes, so you stop the failure-to-file penalty from applying. Also, if you owe taxes, you have choices including setting up an installment agreement with the IRS, applying for an Offer in Compromise, or obtaining a hardship status. The tax professionals at Gudorf Tax Group will review your options with you and get you on the right track to bring you back into compliance. Schedule an appointment today.

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