People fail to file and pay their tax returns on time for many reasons: because they suspect or aren’t sure if they owe taxes for a specific tax year, because their bookkeeping is a mess, or simply because they’re afraid of the whole process and would rather avoid it.
Taxes that haven’t been paid when they are due are called “back taxes,” and they can be a huge headache. If you owe back taxes, the Internal Revenue Service can do things like:
- Penalize you
- Charge additional interest
- Withhold any tax refunds you might be entitled to
- File a return for you
- Seize your assets
- Ask the State Department to prevent you from renewing your passport
Owing back taxes to the IRS is serious, and the sooner you get them filed and paid, the better.
Why do you need to file and pay back taxes?
Every year, you need to file a tax return and pay any taxes you owe based on that return. Even if you suspect you might not owe taxes for this year, you still need to file: it’s the law.
Besides the fact that it’s legally required, there are four main reasons why you need to catch up on your taxes as soon as possible:
1. The IRS might charge you penalties and interest
If the IRS finds out that you’ve been late paying your taxes, you might be charged penalties for any number of reasons, including:
Missing a due date
Late filing comes with a minimum penalty of $205. If you owe less than that, it’s 100 percent of your owed amount. For every subsequent month that you don’t file taxes, you pay another 5 percent of the unpaid tax each month.
You’ll have to pay an additional 0.5 percent of unpaid tax every month until you pay your original tax bill, up to a maximum 25 percent of your total tax bill.
Thankfully, these two penalties don’t stack. If you are late to both file and pay, you will only pay the 5 percent per month interest fine.
Undercalculating your taxes
If the IRS finds that you owe more in taxes than you originally calculated, you have 21 calendar days to pay the additional amount. Otherwise, 0.5 percent interest per month will begin to accumulate.
If you substantially under-report how much tax you owe, or the IRS finds you were intentionally negligent in any aspect of your taxes (i.e., you haven’t just made a small mistake), the penalty is a 20-40 percent increase in taxes owed.
Submitting a specific tax form late
If you’re late returning a W2 (for employees) or a 1099 (for contractors), the fine is a maximum of $50. If you’re late returning a 1065 form (for partnerships) or a 1120S form (for S-Corps), the fine is a maximum of $195 a month per partner.
2. You might be leaving money on the table
If you’re certain you don’t owe taxes for a specific year, it’s still worth your while to file, especially if you’re entitled to a return. There’s no way to know for sure how big your final return will be unless you file with the IRS first, so don’t delay.
This goes double if the IRS ever files a Substitute for Return—that is, if they file a tax return for you, rather than waiting for you to file one. When they do that, the IRS doesn’t account for your tax credits and deductions.
3. You might need those returns for a future loan
Almost every kind of loan requires some form of income verification, whether it’s a student loan for your children, your home mortgage, or a loan for your business. One of the most popular methods of income verification is to provide tax returns for each fiscal year. If you haven’t filed your taxes and you need your income verified, you might be stuck in an awkward position.
4. You could lose out on Social Security benefits
If you’re self-employed, you need to pay into Social Security through your taxes. Not paying those taxes or failing to report your income for those years could mean that you have trouble qualifying for those benefits later because these benefits are based on your income and the amounts you paid into Social Security in the first place.
How late can you file?
You cannot file your taxes late: as soon as the April 15th deadline passes, your tax return is considered overdue.
You might be able to file for an extension by filing IRS Form 4868, but you’ll still have to pay your taxes—and any interest or penalties you’ve accrued—on time. You could face penalties if you don’t.
And remember: just because you’ve managed to put off filing your taxes for a few years doesn’t mean you’re off the hook. The IRS can legally collect tax debts that are up to 10 years old, which means that it always pays to file a late tax return and pay down your tax debt.
Filing back tax returns
No matter what your situation, here’s what you’ll need to do to take care of your back taxes if you’re filing your taxes as a sole proprietor, partnership, C corporation, or an S Corporation.
Step 1: Talk to a tax resolution expert
Tax resolution, also sometimes called tax settlement, is the process of resolving any debts you owe to the IRS—because you were hit with a penalty, because you have unpaid taxes, because the IRS levied your assets, or for any other reason.
A good tax expert—usually an enrolled agent, a CPA, or a tax attorney—can help you appeal an audit or a fine, resolve payment and collection issues, and negotiate a debt settlement with the IRS. They can also help you negotiate an installment agreement, which is a payment plan that allows you to repay your debts over time.
If you’re in particularly dire straits, they might, in some rare cases, even be able to reduce your debts altogether through an offer in compromise. Use the IRS’s online OIC Pre-Qualifier tool to see whether you may be eligible for one right now. You can find step-by-step instructions for submitting an OIC on the IRS website.
Just be sure to look out for OIC scams. Scammy tax preparation shops tend to pop up during tax season, and many of the claims that these disreputable companies make—that they can “negotiate” away fines or even erase your debt altogether—are misrepresentations.
If you can’t afford a tax attorney, your local tax clinic might be able to offer you low-cost legal assistance. Check out the Taxpayer Advocate Service’s directory of low income taxpayer clinics to find one near you.
Step 2: Stop ignoring the IRS
If the IRS has started charging you penalties or moved to levy your assets, it’s likely because you’ve ignored their communications or failed to follow up.
Once you’ve received the go-ahead from a tax expert, re-establishing contact with the IRS and letting them know that you intend to resolve your tax liability is the first thing you’ll need to do to get back in good standing.
If you’re the subject of a levy, an expert can help you ask the IRS to release you from the levy. If the IRS turns down your request, you can appeal that decision. For a full rundown of your appeal rights, consult Publication 1660, Collection Appeal Rights (PDF).
The IRS might stop applying more penalties or levying your assets if you enter into a payment agreement with them. They will also be more lenient if they determine that the fees they’re levying are causing you financial hardship and preventing you from meeting basic, reasonable living expenses.
Step 3: Get your books in order
Another big reason why people fall behind on their taxes? They simply don’t know how much they owe. If your books are a little messy, follow these steps to get them back into order:
Bring together all your records and receipts
Missing records can be one of the most stressful parts of filing your taxes—but also one of the most easily avoidable. The first step to getting any proper bookkeeping system up and running is to start retaining all of your records and receipts, including:
- Cash register tapes
- Deposit information (cash and credit sales)
- Canceled checks or other proof of payment/electronic funds transferred
- Credit card receipts
- Bank statements
- Petty cash slips for small cash payments
- Accounts payable and receivable
- Payroll records
- Tax filings
- Previous year income tax returns
- W2 and 1099 forms
- Any other documentary evidence that supports an item of income, deduction, or credit shown on your tax return
Reconcile your bank accounts
“Reconciling” is just a fancy accounting term for “making sure your bank and business records match.” And that’s exactly what you should do before you overhaul your bookkeeping system or hand your books over to a tax professional. Doing so can save you and your bookkeeper loads of time and trouble.
Separate personal and business expenses
Not separating personal and business expenses can become a huge headache around tax time. The probability of a bookkeeping error increases, and it generally takes more time to sort through expenses when they’re mixed up in one account this way. The sooner you open a small business account and separate your personal and business accounts, the better.
Digitizing your records is a great way to make sure you don’t lose them. Here are some tools that can help:
A dedicated business document scanner, like Fujitsu’s ScanSnap and the Kodak Alaris. These machines can process large numbers of tax documents at once and take care of the filing process for you, saving you hours of work.
A bookkeeping solution like Bench (hey, that’s us!). Your Bench subscription includes unlimited document storage, which means you can keep every receipt, invoice, or IOU in the same place as your bookkeeping.
Collect W-9s, 1099s, and W-2s
If you paid an independent contractor more than $600 this year, you’ll need to submit Form W-9 (a form that requests a contractor’s taxpayer information) and a Form 1099-MISC (what the IRS uses to track payments to independent contractors). If you have employees, you need to file a W-2 for each of them.
Gathering and filing these can take a while, so make sure to give yourself lots of lead time. If you’re not sure whether you need to file one this year, check out our guide to filing 1099s.
Step 4: Make your payments and plan for the future
Once you’ve consulted with a tax professional, made contact with the IRS, cleaned up your books, and filled out the relevant tax forms, you’ll need to make any necessary payments. Regardless of how your back tax repayment journey ends—in an installment plan that has you paying a certain amount of money per month, an asset levy, or a large one-time payment—you’re going to need to send the IRS some money.
If you’re handling this part yourself, remember that while you can use an online tax preparation service to complete the forms, you won’t be able to e-file your back tax return. You’ll need to print out the tax forms and mail them directly to the IRS. You can find the correct address listed in the 1040 instructions for the tax year you’re filing.
Going forward, even if you owe as little as $1,000 in taxes, the IRS usually requires you to make estimated tax payments through the year. Setting aside tax money becomes a lot less painful if you follow a few simple rules:
Get clear on your obligations
If your business hires employees, in addition to paying self-employment tax and income tax, remember that you’ll also have to deal with employment (aka payroll) taxes. In addition to these federal taxes, there are also a variety of state and local taxes you might need to pay, including sales, franchise, property, and excise taxes.
Read up about state-specific taxes well ahead of time (these should be available on the website for your state’s tax authority) and work with your CPA to make sure you aren’t forgetting any.
Open a separate account
To avoid the temptation of dipping into your tax savings, you should keep them away from your day-to-day finances in a separate business bank account. If you don’t want to have to think about setting aside money every month or quarter, set up recurring, automatic bank transfers into the account.
How Bench can help
If you’re behind on your taxes, you’re likely behind on your bookkeeping as well, but don’t worry: we’ve got plenty of experience with situations just like these.
Bench Retro provides emergency support for taxpayers who are more than two years behind on their bookkeeping. Retro can help you sort out your books and maximize your deductions, often lowering the amount of tax owed.
Once your books are caught up, our tax partner 20/20 Tax Resolution can step in, getting your back taxes filed and even representing you in front of the IRS.