Even the best of us can admit to having at least one bad financial habit. Perhaps it is overspending on small items, not shopping around for a better price, or letting the bills pile up on the kitchen table. One of the most common and costly bad habits is putting off filing your taxes.
According to TurboTax, 27% say doing taxes is worse than getting a root canal, and 72% would rather deep-clean their bathroom. The IRS reports that 10 million taxpayers neglect to file every year.
In my practice as a trust and estate CPA, we sometimes discover that the decedent (the person who has passed away) had not filed tax returns for several years before their death. If you are the administrator or trustee settling an estate, you are responsible for filing the final return of the decedent and any unfiled returns.
Reasons for filing late
You might be wondering why someone would not file their returns. After all, filing is relatively simple for about 90% of us, and most taxpayers look forward to receiving refunds. However, I have found that some busy business owners, landlords and investors, who often file more complex returns that are more costly and time-consuming to prepare, often put off filing.
One couple I met were both hard-working physicians. They spent years opening clinics that provided medical care in poor communities. The work was meaningful and the hours were long, so filing income tax returns kept getting pushed to the bottom of their to-do list. A tax preparer friend assured them that it was not an issue since they probably did not owe.
What they did not know is that when taxpayers do not respond to notices to file, the IRS and, more frequently, the FTB can assess taxes based on the information reported by others, often without the deductions the taxpayer may be entitled to claim. As a result, the amount they assess can be much higher than the actual tax owed. The couple eventually had to file to prove they owed $20,000, not the hundreds of thousands of dollars the taxing agencies claimed they owed.
The IRS offered no relief, and the penalties and interest due were almost as much as the tax. However, if the couple could have shown “reasonable cause” for the late filing, the IRS would have been more lenient.
Examples of reasonable cause could be a serious illness or death in the family, loss of a home or job, or some other tragedy that occurred that prevented them from filing. In this example, the IRS did not consider being too busy a valid excuse for not filing.
In another case, a retired couple asked for my advice after several years of not filing. The husband had developed a gambling addiction. The casinos reported winnings to the IRS, and he knew that filing the returns would force him to disclose to his wife how much of their retirement savings he had lost gambling. Eventually, she found out anyway, and they filed the returns.
Fortunately, they were able to settle the balance with the help of a tax attorney, but, as part of the agreement, the husband had to promise to get help for his gambling addiction, which the IRS can determine is a serious illness.
You can see from these examples that no matter how bad a nonfiler’s situation may seem, millions of taxpayers resolve issues with the IRS every year. Here is some advice to help if you or someone you know has fallen behind.
How to get caught up
First, determine whether you are actually required to file. The IRS website has a tool you can use at https://www.irs.gov/individuals/check-if-you-need-to-file-a-tax-return. A licensed tax professional can also help determine whether a return is required for each year in question.
Second, we all know the standard filing deadline is April 15th, with an extension available until October 15th. What many do not know is that these are the deadlines for filing if you owe. If, instead, you are expecting a refund, you generally have three years from the due date to claim it at the federal level and four years in California. So, if you are behind, but do not expect to owe, this might make you feel better.
Third, and this is the most important point: file on time even if you cannot pay. Many people avoid filing because they are afraid they owe, but filing late makes the problem worse. If you cannot file in April, make sure you file an extension. The penalty for not filing by the deadline starts right away, is 5% per month on the balance owed, and reaches its maximum of 25% of the tax after only five months.
The failure-to-pay penalty is only 0.5% per month (6% a year). Filing the return stops the larger failure-to-file penalty from accruing. You can address the payment issue separately and can often ask that the late payment penalties and interest be abated if you have a good reason for not paying.
If you are stuck because you cannot locate your tax documents, or you are unsure when you last filed a return, you can obtain transcripts (of forms others reported to the IRS, including W-2s and 1099s) and your filing and payment history online at https://www.irs.gov/individuals/get-transcript. Your tax professional can also do this for you.
Once your returns are filed and processed, the IRS will send you a bill. At that point, you have more options than most people realize.
Depending on your circumstances, you may qualify for additional time to pay if you can satisfy the balance within a few months, an installment agreement that allows you to pay over time, an offer in compromise if you can demonstrate that you will never be able to pay the full amount, or currently not collectible status if paying your taxes would prevent you from meeting basic living expenses.
Getting help
The most important thing is to respond to every IRS notice and stay in communication. Do not ignore the letters, even if you cannot pay. The IRS is generally willing to work with taxpayers who file their returns, respond to correspondence and make a good-faith effort to resolve the balance.
Finally, if you felt your blood pressure rise while reading this, it may be a sign you need professional tax help. Enrolled Agents, CPAs and tax attorneys who specialize in tax resolution work with these situations every day. You do not have to figure this out alone, and the sooner you begin, the more options you will have.
Michelle C. Herting is a CPA, accredited in business valuations, and an accredited estate planner specializing in succession planning and estate, gift, and trust taxation.