We are taking your burning personal finance questions at Ask Yahoo Finance.
This week, Yahoo reader Rebecca asked: “Last year I tried to file my taxes on Turbo Tax, however, when it came to the end, it told me I owed $800 to the state and $900 federally. I did not have the money then [and] after a very long and stressful year of continuously putting off this problem due to other issues I am now panicking. What do I do?”
Rebecca, you certainly aren't alone. American taxpayers came up $385 billion short on income taxes they owed in 2006, according to a 2013 study by the IRS.
While there can be a lot of guilt associated with falling behind on your taxes or simply not filing your tax return at all, the good news is that it doesn’t automatically make you a criminal. But the longer you wait to make things right, the more your procrastination will cost you.
The IRS is actually pretty good about working with taxpayers who can prove they aren’t financially equipped to handle their tax bills. But to get them on your side, you’ve got to show up first. Even if you don’t plan to pay your owed taxes in a given year, there’s still action you need to take.
“In most cases when I have prepared years of returns for them they either have not owed at all or what they did owe was much less than they expected,” says Jeff Haywood, a CPA and tax blogger in Dallas. “Usually some sort of fear has kept them from filing.”
You may think you’re avoiding a hefty tax bill by not filing a tax return. In actuality, you may only be making a small problem a lot worse. Not only will you get slapped with late fees for the taxes you owe, but the IRS will hit you with a failure-to-file fee as well. While you wait to get your act together, those fees (plus interest) are only piling up higher, month after month.
Here’s a rundown of what fees you can expect if you don’t file your taxes:
If you don’t file your taxes at all (which is different from not paying your taxes). The IRS charges taxpayers who fail to file federal taxes (a form 1040) 5% of their unpaid taxes for each month their tax return is late (this fee maxes out at 25% of the total tax bill). On top of that penalty, once 60 days have passed and you still haven’t filed, you will pay another fee -- a minimum of $135 or 100% of the taxes you owe (whichever is less). You can avoid these fees if you can prove reasonable cause for not filing on time (like a medical emergency).
You can apply for an extension to file your taxes until Oct. 15, but that doesn't mean you get six extra months to pay if you have taxes due. The IRS levies a 0.5% fee on your unpaid taxes every month until the balance is paid. The deadline for an extension request is April 15.
If you've filed your taxes by April 15 but still can’t pay your tax bill. You’ve done the right thing by filing your taxes anyway. The penalty for paying your tax bills late is actually way lower than failing to file — the above-mentioned 0.5% of unpaid taxes per month.
Your next step might be to file for an extension to pay, which can buy you an extra 120 days. But unless you can prove you had a good reason for not paying on time, the IRS won’t let you off the hook for late fees and interest penalties. That’s why it’s probably best to start an installment plan with the IRS.
“Because of the economic climate going back to 2008, the IRS has become more understanding with these arrangements,” Haywood says.
An installment plan will let you pay your tax bill in monthly increments (up to 72 months), so long as you owe less than $50,000 (for individuals) for one tax year. There are some caveats to consider: the IRS charges an application fee ranging from $43 to $120, and you will still be charged at least 3% interest on your late payments.
If you want to avoid these fees, you can opt to pay your taxes using a 0% interest credit card. But that’s an option you should consider only if you’re sure you can pay the card off by the end of the promotional period.
What’s the worst that could happen?
The IRS may be understaffed and overworked, but because they use special computer systems to weed out late tax filers, you can expect to receive a letter from them eventually, Haywood says. The IRS will start by sending you letters and eventually, they’ll start playing hardball.
At a certain point -- which can vary based on your responsiveness to the IRS -- the agency can freeze your bank accounts, put a lien on your house, garnish your future wages (including benefits like Social Security) and dip into future tax refunds you may be entitled to.
Keep in mind that the IRS keeps no time limit for collecting unpaid taxes and charging penalties for not filing. But the government has up to six years from the date of any nonfiled tax return was due to criminally charge you with failing to file a return.
The rules for penalties change almost every year, so we recommend working with a CPA if you’ve fallen behind on your taxes. Find one in your area by asking friends and family for referrals, or through the American Institute of CPAs. See IRS.gov for more details on late fees.