File an extension? Better file a tax return.
One of the biggest mistakes taxpayers can make is to not file a required tax return. The penalty for not filing is bad: If taxpayers file five months or more after the due date, the penalty is 25 percent of the tax they owe. If the IRS proves that taxpayers didn’t file because they had fraudulent intentions, the penalty can be as high as 75 percent of the tax they owe.
The IRS has systems to identify taxpayers who haven’t filed a required tax return. A major way is through third-party information statements, such as Form W-2 and 1099. These statements report taxpayers’ income, and the IRS uses them to identify people who haven’t filed their returns. The IRS also uses taxpayers’ filing history to question whether they should file a return. In all, the IRS believes that more than 7 million taxpayers don’t file a required tax return every year.
The IRS is especially interested in pursuing people who file an extension but don’t file their returns. This past tax season, 11.6 million taxpayers filed an extension, giving them six more months to file their returns.
From the IRS’ perspective, it only makes sense that taxpayers who file an extension would also follow up and file a tax return. After all, with the extension, taxpayers are putting the IRS on notice that they have a tax return to be filed, and that they’ll file it on time.
What does the IRS do when an extender doesn’t file? A recent Treasury Inspector General for Tax Administration (TIGTA) report provides great insight into the IRS process – and the need for the IRS to pursue extenders who don’t file.
The IRS is set to pursue more extenders who don’t file
In the study, TIGTA investigated taxpayers who filed an extension but didn’t file a return before the extension expired. For 2012 and 2013, TIGTA found 1.9 million of these people. For these two years, a computer glitch in IRS systems meant that it didn’t pursue many of the people who extended their returns but didn’t file. As a result, TIGTA focused on this specific group of nonfilers for the study.
TIGTA found that the IRS lost more than $3 billion in the 2012 tax year alone from not chasing these nonfilers. Because of the study, the IRS started pursuing some of the 2013 nonfilers. They owed an average of more than $14,000 per return. In fact, extension nonfilers owed almost three times more than the total nonfiler population.
TIGTA ultimately concluded that pursuing the extenders who hadn’t filed is low-hanging fruit for the IRS. TIGTA recommended that the IRS use its limited resources to chase this population, especially those with higher incomes.
The IRS agreed with most of TIGTA’s recommendations and agreed to more aggressively pursue extenders who hadn’t filed – because they likely owe a lot of money. Taxpayers who extended their returns but didn’t follow up and file will likely start receiving IRS notice CP59, First Notice of Return Delinquency, a few months after the filing deadline.
“I couldn’t pay, so I didn’t file”
Many late filers ask the IRS to forgive their failure to file penalties, explaining that they didn’t file because they couldn’t afford to pay. The IRS reminds these taxpayers in their penalty relief denial letters that the inability to pay is never a reason for not filing a return.
Fortunately, there are options for taxpayers who can’t pay
If taxpayers owe a tax bill, the IRS will work with them. These taxpayers can ask for an extension to pay of up to four months. They can also set up a payment plan (called an installment agreement) to pay over time.
If taxpayers can prove to the IRS that they are in financial hardship, the IRS won’t ask them to pay more than they can afford, within reason. For taxpayers in extreme hardship, the IRS can defer payment (called currently not collectible status) or possibly even settle with the taxpayers for an amount less than the total bill (called an offer in compromise).
What about ignoring the issue?
Not filing and hoping it goes away is never a good option. The IRS will likely pursue these taxpayers – and the IRS can even file a return for them, to start collecting on the balance. That return (called a substitute for return) will have all the penalties and no deductions or credits in the taxpayer’s favor.
Nonfiling investigations can get serious, with the IRS possibly pursuing more serious civil and criminal charges if taxpayers persist in not filing. What’s more, there’s no limit on the amount of time the IRS has to pursue late returns. However, taxpayers can take comfort that the IRS normally won’t pursue returns past the prior six years (IRS Policy Statement 5-133).
Help is not far away
Taxpayers sometimes let multiple years of unfiled tax returns pile up, assuming their situation can’t be corrected. That’s not the case. Taxpayers who need help filing back tax returns, filing by the deadline, or finding options for payment or penalty relief should consult a tax professional.
The tax professional can help with old tax years by requesting income information from the IRS to help file an accurate return. They can also work with the IRS to navigate possible penalty relief options and payment arrangements that may be available, based on the taxpayer’s financial situation.
The right course is to file on time, minimize penalties and get into an arrangement with the IRS. Whether taxpayers are late on one extended return, or have many years of returns to file, an experienced tax professional can help them get right with the IRS now and into the future.
By Jim Buttonow, guest contributor
Jim Buttonow, CPA, CITP, directs product development for H&R Block’s Tax Audit & Tax Notice Services. Previously, he was vice president of product development and co-founder of tax technology company New River Innovation. A CPA and former IRS Large Case Team Audit Coordinator, Jim worked at the IRS for 19 years. Since leaving the IRS, Jim has represented many clients before the IRS and has been in private practice since 2006. Jim’s articles have appeared in the Journal of Accountancy, Accounting Today and various state CPA society magazines. In 2012 and 2013, Accounting Today named Jim one of the Top 100 Most Influential People in Accounting.