FAILURE TO FILE TAX RETURNS
George Wilson Adams CPA MBA January 11, 2020
Some People Fall Behind
In my career I've helped many people who have fallen behind in filing tax returns. Failure to file can occur for many reasons, including personal tragedies, divorce, medical issues, etc. Taxes are not the most important thing in life. The crucial question faced by those who are out in the cold and have not filed for many years is where to start.
Where to Start
I've helped individuals who come out from the cold and haven't filed taxes in many, many years. Frequently these people are being chased by the IRS and Maine Revenue Services. The tax law gives the IRS authority to prepare a tax return (called a 'substitute return') on behalf of a taxpayer who hasn't filed. Obviously any return prepared by the IRS is unlikely to be in the best financial interests of a taxpayer.
So where should non-filers start? My own informal rule of thumb to file for at least the prior three years. Many non-filers may have no tax records of any kind or may have lost important records. Copies of important tax documents can be requested from the IRS using Form 4506-T and are available for free.
Another important thing to do is hire a qualified accountant or attorney to represent you if you have not filed for many years. A professional representative will guard your interests and help you navigate the complex rules that apply to these situations. IRS Form 2848 can be used to name a person to represent you.
Why You Should Get Back Into the System
In general the IRS has ten years to collect unpaid taxes once a return is filed by the taxpayer, and generally three years to audit a filed return. If no tax return is ever filed then the statute of limitations countdown clock may never begin ticking. With taxes as with other areas of life it is nice to achieve closure and finality, and reach the ninth inning when it is 'game over.' This will not happen if a return is never filed.
Another reason to get back into the system and resume filing taxes on a current basis is to help individuals obtain bank loans, mortgages, and good credit. All banks will request copies of tax returns as a part of their documentation process for mortgages and other secured loans.
Yet another reason to file back tax returns is to recover any refunds available before the statute of limitations runs out. Taxpayers have 2 to 3 years (depending on various circumstances) to file a return and claim a refund. Claim or lose!
Penalties and Interest
There are two common penalties applicable to late filed returns where tax is due and owing. The penalty for failure to file a timely return is 5% per month up to a maximum of 25%. The penalty for failure to pay tax on time is 0.5% per month again capped at a maximum of 25%. These penalties stop accruing only when the IRS physically receives a tax return.
Penalties can be abated if a taxpayer can show reasonable cause. Many people facing severe medical issues, divorce, or other personal disasters may qualify for complete abatement of penalties. Further, if a taxpayer ultimately does files a return, even if late, the penalty for late payment of tax is, in effect, waived. In addition to all applicable penalties the IRS charges interest on any unpaid tax, which is the federal short term rate (determined quarterly) plus 3%. Interest can never be abated.
The Worst Case Scenario: Tax Evasion
The IRS has enormous power and discretion to assess criminal penalties against non-filers. However, they resort to such penalties usually only in extreme cases where an individual has a long and repeated history of non-compliance. If you are far behind in filing taxes the best thing you can do for yourself is to hire a CPA or Tax Attorney to represent you and get back into the system. Do this BEFORE there is a knock on your door or a certified mail letter addressed to you.
Offer In Compromise
After back tax returns have been filed the next step is to deal with the consequences, which may be a large tax bill from the IRS. No one should be threatened by this. Taxpayers who owe up to $50,000 usually qualify automatically for a payment plan that can stretch payments out up to 6 years.
Another alternative is to file for an Offer In Compromise ("OIC") using IRS Form 656. Two grounds for filing for an OIC are (1) inability to pay; and (2) doubt regarding the amount due. Beware of internet-based firms that offer to settle past tax debts for 'pennies on the dollar.' The truth is that an OIC is not applicable for some people. Taxpayers should be screened in advance to see if filing an OIC makes sense. If you do pursue an OIC for past tax debts I strongly recommend hiring a local professional to work with.
An OIC is a lengthy process that can take 6 to 18 months. Sometimes an initial OIC is rejected by the IRS. But this is not necessarily the end. Taxpayers can file an appeal for a rejected OIC.
George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339
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