Understanding and Avoiding the Failure to File Penalty

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We’re sure you agree that your hard-earned money should remain where it belongs – in your pocket. So, wouldn’t you want to take every possible step to avoid paying the government more than you need to? After all, taxes are stressful enough even without the looming threat of penalties for late filing and payment.

However, while failing to file a return (if you’re required to file one) invites penalties, you should remember there are mechanisms in place to address this – prevention and cure, if you will. For instance, as a matter of prevention, you could get a tax extension if you need more time to file. Or, if you find yourself unable to clear your dues and penalty, you could apply for an IRS payment plan.

So, if you suspect you may have missed the bus this past tax season, read on to understand the failure to file penalty and your options: how to resolve it, prevent it, and better prepare for the upcoming tax season.

What Is the Failure to File Penalty?

Let’s say that you had to file a return, i.e., you met the threshold for filing one, but unfortunately failed to do so for whatever reason. What happens in this situation?

Well, at this point, you incur the failure to file penalty.

Now, the penalty you owe is calculated based on the delay in submitting the tax return and the outstanding tax amount as of the initial payment deadline (i.e., even if you managed to get an extension to file your taxes, the original due date will apply). Your unpaid tax refers to the overall tax obligation you need to show on your return, minus payments made in the following ways:

  • Withholding
  • Estimated tax payments
  • Eligible refundable credits

How is the failure to file penalty calculated?

This failure to file penalty is calculated as follows:

  • The penalty equals 5% of your unpaid taxes for each month or portion of a month your tax return is overdue. However, the penalty does not exceed 25% of your unpaid taxes.
  • If the failure to file penalty and the failure to pay penalty (i.e., the penalty levied if you fail to pay your taxes before or by tax day) are applied in the same month, the failure to file penalty decreases by the failure to pay penalty amount for that month. This results in a combined penalty of 5% for each month or portion of a month your return was delayed.
  • After 5 months without payment, the failure to file penalty reaches its limit. Yet, the failure to pay penalty persists until the tax is settled, up to a maximum of 25% of the unpaid tax by the due date.
  • For returns delayed by over 60 days in 2023, the minimum failure to file penalty is $450 or 100% of the tax on the return, whichever is less.

Does the IRS charge interest?

To add interest to injury, yes - the IRS does charge interest on penalties. The date from which this interest accrues depends on the type of penalty. And it accrues till your balance is paid off fully.

How will I know if I owe the failure to file penalty?

The IRS certainly won’t be bashful about it. They will send you a notice or letter if you owe the failure to file penalty.

Paying the Failure to File Penalty

You could pay off your tax dues and penalties through your bank account, a debit or credit card, or a digital wallet. The IRS also accepts partial payments toward your dues; however, interest and penalties will continue to accrue till the full outstanding amount is cleared.

While paying it off may be the simplest way to handle this situation, we know it may not be the easiest; financial hardship can severely hamper your ability to clear your dues. Relievingly, for such situations, the IRS does have a mechanism in place – payment plans.

Payment plans

If you are an individual filer / sole proprietor / independent contractor, here are your options besides full payment:

  • Short-term payment plan: Per this plan, you have the option of paying off your tax obligations in 180 days or less.
  • Long-term payment plan: This type of plan is also called an installment agreement. If you need more than 180 days to clear your tax dues, this option allows you to pay it off in monthly installments.

If you satisfy the following criteria, you could use the IRS Online Payment Agreement tool to submit an application for either a short- or long-term arrangement:

  • Long-term payment plan (installment agreement): You can apply for this if you owe $50,000 or less in combined tax, penalties, and interest; filed all required returns; and need more than 180 days to pay it off.
  • Short-term payment plan: You can apply for this if you owe less than $100,000 in combined tax, penalties, and interest; have filed your returns; and can pay off your taxes in 180 days or less.

If you are a business, you can apply for the long-term payment plan (installment agreement) where you pay off your taxes in monthly installments.

If you fulfill the following condition, you can use the IRS Online Payment Agreement tool to apply for either a short- or long-term arrangement:

  • Long-term payment plan (installment agreement): You owe $25,000 or less in combined tax, penalties, and interest and have filed all your returns.

How can I apply for a payment plan?

You can apply online – this is the easiest way. Offline application may come with higher setup fees, but you can apply for an IRS payment plan by mail (by filling out IRS Form 9465 – the Installment Agreement Request) or by phone (call the IRS’s main number).

How Can I Dispute a Penalty?

If, for some reason, you disagree with the amount you owe in the form of the penalty, you have the option to dispute it. What you can do in such a case is reach out to the IRS by calling them on the toll-free number provided in the top-right corner of your notice or letter, or submit a written request explaining the grounds on which you want them to reconsider the penalty. You must remember to sign and send the letter along with any relevant supporting documents to the address specified in your notice or letter.

When doing this, you must have the following information ready with you:

  • The specific notice or letter that the IRS issued to you
  • The penalty that you want the IRS to review
  • A detailed rationale for why you believe the penalty should be removed/reconsidered

If you haven’t received a notice, you should seek IRS assistance via telephone.

How Can I Remove/Reduce a Penalty?

If you can show the IRS that you acted in good faith and had a reasonable cause for failing to file your return, the IRS can choose to remove or reduce some penalties.

How Can I Avoid a Penalty?

Now the answer may be straightforward – file your taxes by tax day, which is the deadline for filing federal income tax returns. Each year, this day falls on April 15, unless it coincides with a weekend or a holiday.

Fortunately, there is a workaround if you find yourself unable to file your return by tax day – we’re referring to tax extensions.

What is a tax extension?

A tax extension is a formal request that you, as a taxpayer, can make to the IRS, asking for additional time beyond the regular tax filing deadline to submit your tax return. This extension usually prolongs the deadline by six months, moving it from April 15 (or April 18 in the case of filing 2022 returns) to October 15 (which was October 16 this year). However, these requests must be made by the original deadline.

How do they work?

Tax extensions come with several benefits, the main one being that they lengthen the filing deadline. This gives you more time to gather the necessary records and information you need to file your returns.

But it’s extremely important to know what tax extensions don’t do: They do not extend the timeline for settling your tax liabilities. So, even if you do manage to get an extension for filing your tax return, you must ensure that you estimate and settle any owed taxes by the original deadline to avoid more potential penalties (the failure to pay penalty) and interest.

Therefore, an inability to pay is not a good reason to file an extension. If you find that you are unable to pay, what you can do is apply for one of the IRS’s payment plans (covered earlier).

What Is a Substitute for a Return?

Ideally, you should file all your due tax returns, even if you can’t pay your taxes in full. If you fail to file your returns, the IRS may file a substitute return for you. To do this, the IRS will use available information, like W-2 forms and 1099s, to estimate your income and calculate the tax owed.

However, a substituted return is a basic return in that it may not take into account potential deductions or credits that you may be eligible to claim. Consequently, you may end up owing more in taxes on a substituted return than if you were to file your return yourself.

Therefore, it is generally in your best interest to file your own return to ensure you take advantage of all eligible deductions and credits. Once you file your return, the IRS typically makes corrections to your account to ensure accurate figures are recorded.

What happens after a substitute for a return is filed?

The substituted return that the IRS prepares for you will lead to a tax bill. If you fail to clear this bill, the IRS’s collection process gets triggered. This, in turn, could lead to a levy or lien. If you continually fail to file, the IRS may take additional enforcement measures, such as additional penalties and/or criminal prosecution.

What Are the Benefits of Filing Returns?

In addition to ensuring that you’re on the right side of the law, filing a return also comes with the following benefits:

  • Receiving refunds: Some individuals may receive a refund upon filing their tax return if they paid more taxes than they owe. For instance, if your employer deducted taxes from your paycheck, you could be eligible for a refund.
  • Claiming tax credits: Certain tax credits, like the earned income tax credit (EITC) or child tax credit, can only be claimed by filing a tax return. These credits can significantly reduce your tax liability.
  • Qualification for government programs: Some government assistance programs, like student financial aid or subsidized housing, may require proof of income through filed tax returns.
  • Establishing financial history: Regularly filing tax returns can help establish a consistent financial history, which may be useful for future financial endeavors.
  • Avoiding future complications: Filing tax returns on time and accurately can help avoid potential issues or audits from tax authorities in the future.
  • Self-employment and business deductions: For self-employed individuals and business owners, filing a return allows for the deduction of business expenses, potentially reducing the overall tax liability.
  • Mental peace: Filing a return ensures that you are in compliance with tax laws, providing peace of mind and reducing the risk of future tax-related stress or complications.

FAQ: How Do I Know If I’m Required to File a Return?

The answer to this depends on various factors:

  • Your total income
  • Your filing status
  • Your age
  • Your dependency status

Generally speaking, if you are a US citizen or permanent resident and you earn above a specific threshold during the year, you will be required to submit a tax return. Let’s take a look at what this threshold was for your 2022 returns.

Filing Status Taxpayer’s Age at the End of 2022 Gross Income Threshold
Single Under 65 $12,950
Single 65 or older $14,700
Head of household Under 65 $19,400
Head of household 65 or older $21,150
Married filing jointly Under 65 (both spouses) $25,900
Married filing jointly 65 or older (one spouse) $27,300
Married filing jointly 65 or older (both spouses) $28,700
Married filing separately Any age $5
Qualifying surviving spouse Under 65 $25,900
Qualifying surviving spouse 65 or older $27,300

What is gross income?

Well, your gross income refers to the total amount of income that you or your business earns before any deductions or expenses are taken into account. This includes all sources of income such as:

  • Wages/salaries
  • Business profits
  • Rental income
  • Any other money received

It is the starting point for calculating taxable income, which is the amount on which taxes are calculated. Gross income does not take into consideration any tax deductions, exemptions, or credits that may apply.

But even if your earnings fall below the required filing threshold set by the IRS (meaning you need not file a return), you could benefit from filing one because it could lead to a refund. This is relevant in the following situations:

  • Your pay had federal income tax withheld from it.
  • You made estimated tax payments.
  • You meet the criteria for claiming tax credits like the earned income tax credit or child tax credit.

Filing status

This is extremely relevant too. As you saw in the table above, different filing statuses have distinct income thresholds, so you should also take into account your potential filing status. There are five filing statuses:

  • Single
  • Head of household
  • Married filing jointly
  • Married filing separately
  • Qualifying surviving spouse

What if I’m self-employed?

If your net earnings from self-employment are $400 or more, then you will have to file an annual return and pay estimated taxes on a quarterly basis. This estimation may be tricky business if your income is unpredictable, which is where you can annualize your income so you don’t end up underpaying and incurring penalties.

What if I’m a dependent?

Depending on your gross income, you may have to file a return. If a dependent cannot file for themselves, a parent or guardian must do it for them.

What’s an easy way to figure out if I need to file a return?

You could use this IRS tool – Interactive Tax Assistant. This tool can answer common tax law questions in specific regard to your circumstances. Also, based on your input, it will help you determine if you need to file a return.

It can help you answer questions related to the following:

  • Filing status
  • Dependent status
  • Income taxability
  • Credit eligibility
  • Expense deductibility

Key Takeaways

  • Failing to file a tax return can lead to penalties and, in extreme cases, collection actions.
  • There are options for prevention and resolution, including filing for a tax extension and setting up an IRS payment plan.
  • The failure to file penalty is calculated based on the delay in submitting the tax return and the unpaid tax amount.
  • Interest is charged on penalties from a specific date until the full balance is paid.
  • The IRS will notify you if you owe a failure to file penalty.
  • Payment can be made through various methods, but interest and penalties continue to accrue until the full amount is paid.
  • Payment plans are available for individuals and businesses to settle tax obligations in installments.
  • Disputing a penalty is an option if you disagree with the assessed amount.
  • Filing returns is important for various reasons, including claiming refunds, tax credits, and eligibility for government programs.
  • The IRS’s Interactive Tax Assistant tool can help you determine if you need to file a return based on your specific circumstances.

Conclusion

It is crucial for every taxpayer to understand the implications of failing to file a tax return. Filing returns is not only a legal obligation; it also significantly impacts your financial well-being. Therefore, taking proactive steps, such as filing for a tax extension or setting up a payment plan, can help mitigate penalties and collection actions.

Additionally, being aware of the various benefits of filing returns, including claiming refunds and tax credits, can help you plan better for tax season. Remember, accurate and timely filing ensures compliance with tax laws and provides peace of mind for a secure financial future.