This is a continuation of the article that first appeared in our April 2019 issue. For Part 1, look here.
What happens when a taxpayer that is entitle to a refund files a late return or never files?
The Internal Revenue Services’ (IRS) “general rule” is that in order to claim a tax refund, the taxpayer must file the tax return within 3 years of the due date. Example: The due date to file 2017 tax return was April 17, 2018 (or October 15, 2018 if the taxpayer requested an extension). In order to claim the refund, the taxpayer will have to file the 2017 tax return on or before April 17, 2021 (or before October 15, 2021 only if a filing extension was granted).
If the 3-year statute of limitation has passed, the taxpayer will not receive the refund unless there are extenuating circumstances. This rule also applies to any tax credits such as the Earned Income Tax Credit. The taxpayer will not receive any tax refund nor tax credits if the tax return is filed after the 3-year deadline. Does it matter if a taxpayer with a refund due does not file a tax return at all? Yes, it does matter. By law, we are required to file as long as we have taxable income or there is another filing requirement.
What happens if a taxpayer with a balance due files the tax return after April 15?
Penalties and interest – that’s what will happen…and they are awful! The IRS charges two different penalties. There is the Failure to File Penalty, which starts accruing the day after the tax filing due date. This penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late. Then, the IRS charges a second penalty, which is the Failure to Pay Penalty. The Failure to Pay Penalty is 0.5% of the taxpayer’s unpaid taxes for each month or part of a month after the due date. It also starts accruing the day after the tax filing due date. And finally, there is the interest that accrues on any unpaid tax from the due date of the return until the date of payment in full. The interest rate is determined quarterly and is the federal short-term rate plus 3%. A taxpayer can and must file a late tax return even with a balance due any time after the due date, however, the sooner the better.
What happens if a taxpayer files and has a balance due and he/she cannot afford to pay?
Ten years of notices, financial hardships, headaches, and emotional distress. The IRS has 10 years from the date the tax was assessed to collect on the tax debt. Ten years can seem to be an eternity, especially for the low-income taxpayers that cannot afford to pay back to the IRS after losing their jobs due to disability or loss of household income, among other reasons. This is why the sooner the taxpayer files the late return, the better. The longer the taxpayer waits to file a late return with a balance due, the higher is the tax debt and the longer the IRS will have to collect on it. During those 10 years, the IRS can garnish and levy wages, Social Security benefits, future tax refunds, bank accounts, and they can even seize any property the taxpayer might own. Finally, the IRS will file a federal tax lien against the taxpayer if the tax debt for any given year is more than $10,000.
What happens if a taxpayer never files the tax return?
Good luck with the IRS! If a taxpayer fails to file, eventually, the IRS will file a substitute return on behalf of the taxpayer and they do not need the taxpayer’s consent to do so. Before filing a substitute return, the IRS will make many attempts to get the taxpayer to file the late return.
There are some “inconveniences” from having the IRS file a substitute return. One inconvenience is that the substitute return filed by the IRS might not give the taxpayer any tax credits, tax deductions or exemptions that the taxpayer might be entitled to receive. Then, there is the fact that if the substitute return shows a balance due, the taxpayer will be forever and ever in debt with the IRS …unless of course the taxpayer pays the tax debt to the IRS. There is not a statute of limitation for the IRS to collect on a substitute return balance due. Also, tax debt that arises from a substitute return cannot be discharged through bankruptcy. The IRS will be collecting until the tax debt is paid in full or paid through an offer in compromise. Can the taxpayer file a tax return after the IRS files a substitute return? Yes, the taxpayer can file after the IRS has filed the substitute return especially if the taxpayer intends to apply for any of the IRS tax debt relief programs in the future. However, bankruptcy is still off the table.
The IRS tax debt relief programs are limited. Applying for any of the IRS programs can be an overwhelming, confusing, rough and an extremely long process for most of our low-income taxpayers. There is no guaranty that the IRS will accept the taxpayer’s request for any of their tax debt relief programs. Therefore, it is in the taxpayers’ best interest to file all required tax returns, even if it is a late return. Sometimes, filing a late tax return can help resolve part of the federal tax controversy or reduce the balance due. The bottom line is that no matter what caused the taxpayer to miss the deadline, taxpayers should file tax returns when required even if it is years past the due date.