The IRS takes owed taxes pretty seriously, which is why missed tax filings are a problem you can’t afford to ignore. Unfortunately, if you do nothing, things can snowball pretty quickly.
In this guide, we’ll break down what happens if you don’t file taxes as a small business owner and how you can get back on track with the IRS.
Though business owners can and do fall behind on their employment and sales taxes, we’re going to walk through the most common issue: income taxes.
I forgot to file my taxes
Before we get into what happens if you don’t file your taxes, we’ll cover the filing due dates.
Taxpayers have different tax filing deadlines depending on their business entity type. In general, S corps and partnerships are due in March, and C corps and sole proprietorships are due in April.
We’ve put together a complete list of federal tax filing deadlines for small business owners. Pencil these dates into your calendar, and be sure to bookmark the page. We revamp it for each tax year, and throughout if the IRS makes accommodations for unexpected events like the pandemic and Hurricane Ida.
Prefer to watch this instead? Check out part one of our three-part video series. Findparts one and part two here. rPa:
I’m sure I don’t owe anything, should I still file?
Everyone’s situation is unique, but if you’ve missed filing your taxes, this likely means you also missed making your tax payments.
If you fall into one or both of these situations, you’ll get hit with IRS penalties. There is a late filing penalty and a late payment penalty.
The amount of these penalties will depend on two factors:
- How long past the tax filing deadline you submit your taxes or pay them
- How much you owe in taxes
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If you don’t file your tax return by the deadline (provided you haven’t filed for an extension), the penalty is 5% of the unpaid tax for each month that return is late.
If you don’t pay your owed tax on time, the standard penalty is 0.5% of the unpaid tax amount for each month it remains unpaid.
Thankfully, both these penalties max out at 25% of the total tax amount owed. This means the 5% failure-to-file penalty maxes out after five months.
If both penalties apply in the same month, the maximum penalty applied is 5%. You pay the 0.5% failure-to-pay penalty and a 4.5% failure-to-file penalty.
When those five months have passed and the failure-to-file penalty has maxed out, the failure-to-pay penalty continues at 0.5% per month, either until you pay or it maxes out at 25%—45 months later.
What’s the difference between not filing and not paying your taxes for three years?
The difference between late filing and late payment boils down to how much you’ll pay in fees. Your penalty amount will depend on the amount of taxes due and how late you file your taxes. Let’s take a closer look.
What Happens if You Don’t File Taxes for Three Years?
If you fail to file your tax return for three years, even if you don’t owe any taxes or choose not to pay them, it can still have consequences. Many individuals may wonder what would happen if they forget to file their taxes or decide not to pay. It’s important to understand the implications of not filing your tax return and not paying taxes, even if you don’t have a tax liability. Here’s a breakdown of what could occur:
- Not filing taxes incurs a penalty of 5% of unpaid taxes per month, capped at 25%. Not paying taxes results in a penalty of 0.5% per month, up to 25%.
- Ignoring taxes for three years can lead to wage or bank account levies, federal tax liens, property liens, potential tax evasion charges, passport revocation, and seizure of tax refunds.
- Not filing taxes means missing out on potential refunds. Resolving the issue after three years is easier and incurs lower fees and back taxes.
- Options for settling tax debt include payment plans, installment agreements, offer in compromise, and penalty abatement.
- Seeking professional help from a CPA or tax professional can guide you through tax relief programs and ensure compliance with the IRS.
Even after three years, you could face more than fees if you ignore your taxes. In addition to the penalties mentioned above, the IRS can:
- Set up a levy on your wages or bank account. The result can be a garnishment of wages and other income.
- File a notice of a federal tax lien, which can limit your ability to take out loans or use your credit.
- File a lien secured to your property, meaning they have a say in any sale of your property or assets and will take the tax payments you owe from the proceeds.
- Charge you with tax evasion if you willfully avoid filing taxes. You could face fines up to $250,000, and even jail time in extreme cases.
- Revoke your passport for tax debt over $50,000.
- Seize your tax refund to repay debts that you owe.
You may also miss out on possible tax refunds by not filing. With the IRS reporting $1.5 billion in unclaimed tax refunds (the average refund is $813), you’re missing out on money due to you.
But remember, once three years are up from the due date of your income tax return, you can no longer claim a tax refund. You won’t receive credit for the refund on your account or be able to apply it to a future return either. However, in general, not paying your taxes for three years will be much easier to resolve than not paying for five or ten years. Not only will it be much easier to get your bookkeeping back up to date, but you’ll also owe less in fees and back taxes.
Let’s see what happens next for failing to file after 5 years.
What’s the penalty for not filing taxes for five full years?
Once you get to the five-year mark, you’ve almost certainly received a few strongly worded notices about your tax liability, with an explanation of penalties and possibly stronger consequences later on.
The first actions that you can expect are penalties and interest applied to your outstanding tax debt. The IRS computes penalties as follows:
- For each month your return has not been filed, a 5% failure-to-file penalty is added to your tax debt.
- Not paying your taxes adds another 0.5% monthly failure-to-pay penalty to the unpaid amount.
- However, if both failure-to-pay AND failure-to-file penalties are applied, the IRS reduces the failure-to-file penalty to 4.5%. As a result, your combined penalty is 5% for each month you have not filed and paid your tax debt.
The good news is that the IRS caps the failure-to-pay penalty to not exceed 25% of your unpaid taxes. While this can still grow to a significant number, it does prevent your total tax burden from ballooning completely out of control.
How would these penalties be applied to your five-year-old tax debt? Here’s an example.
A hypothetical scenario on what happens when not filing for five years:
Let’s say you owe the IRS $10,000 after five years of not filing or paying taxes.
You’re charged both the 4.5% missed filing penalty and the 0.5% missed payment penalty on this amount. This is calculated as follows:
$10,000 x 4.5% = $450 per month in failure-to-file penalties
$10,000 x 0.5% = $50 per month in failure-to-pay penalties
Since the failure-to-pay penalty won’t ever exceed 25% of your unpaid taxes, this penalty total which could otherwise be $3,000 (60 months x 0.5%), is reduced to $2,500 ($10,000 x 25%).
However, the failure-to-file penalty is still added to your $10,000 balance at the rate of 4.5% per month, which is calculated as $450 x 60 months, or $27,000.
Your total penalties for five years on $10,000 of tax debt would then be $27,000 + $2,500 = $29,500.
If you haven’t filed your taxes for five years, the IRS may do it for you
If the IRS has reason to believe you have earned income, but you haven’t filed a tax return in five years, they will file a Substitute For Return, or SFR, on your behalf.
While it may sound like they’re doing you a favor, this is far from an ideal solution for your delinquent tax situation. To complete the SFR, the IRS bases your taxes on financials pulled from your bank account records, contractor payments, and other sources. They don’t include itemized or standard deductions, exemptions, or tax credits that would lower your tax liability. Then the IRS adds the penalties and accrued interest to your already inflated tax debt.
Before taking this action, the IRS sends you an assessment letter along with the SFR. If you fail to respond to this correspondence, the IRS will send a second letter by certified mail to notify you that they will begin the collection process based on the SFR amount.
It goes without saying that the sooner you communicate with the IRS, the better chances you have of avoiding a federal tax lien on your business, or worse, levies on your assets.
What happens if you haven’t filed income taxes for 10 years?
There are a couple types of consequences to consider when you haven’t filed your tax returns with the IRS.
Consequences with the IRS
The IRS may charge you penalties and fees if you have income that you’ve failed to report on your taxes. What’s more, the income the IRS estimates you’ve made will likely be much higher than what you would have filed on your own.
This is because the IRS doesn’t account for tax credits or tax deductions you would have included had you filed taxes yourself. The IRS files a tax return on your behalf using their own accounting—and remember, they don’t have any records of your expenses like rent, equipment, and other deductions that would reduce your tax liability. Fees will then accrue on the IRS’s estimated balance.
The IRS charges taxpayers a failure to file penalty and a failure to pay penalty totaling 5% every month your tax return is late. This fee is capped at a total maximum tax penalty of 25%, however, so the total fees do not grow indefinitely.
If you haven’t filed taxes for several years, the IRS may decide to settle your tax bill by setting up a levy on your wages or bank account. This can result in a garnishment of wages or other income.
The IRS may also file a notice of a federal tax lien, which can impact your financial options in the future. A tax lien by the IRS can limit your ability to take out loans or use your credit. A lien can also limit your sale of property or assets, as the government will now have a say in your transaction and will take the tax payment owed from the proceeds of any sale.
In an absolute worst-case scenario, the IRS can punish those who have been willfully avoiding filing taxes with up to five years in prison and up to $250,000 in fines for tax evasion.
Consequences in other areas for being behind 10+ years
There are many other reasons you can run into issues by not filing taxes. In addition to missing out on possible tax refunds, there are several areas of your life that require you to present your recent income tax returns. If you haven’t filed your taxes recently, you won’t have any tax returns to present!
You may be asked to show your recent tax returns when you apply for a passport, for example. You will almost certainly be asked for tax returns when you apply for a mortgage, rent or other loan. You may also be asked for your recent tax returns when you apply for health insurance.
Your own or your child’s financial aid applications for college require your most recent federal income tax returns as well. Finally, your retirement benefits, like Social Security and Medicare, are tied to the income reported on your tax returns. Failing to file your tax return for many years can jeopardize your future income.
Will I get criminally charged or other penalties for not filing or not paying?
Failing to file or pay taxes can result in penalties and interest charges from the IRS. Surprisingly, the penalty for not filing taxes is usually more severe than the penalty for not paying the owed taxes. To minimize penalties, it is advisable to file your tax return even if you can’t afford to pay the full amount. Filing removes the 5% failure-to-file penalty, keeping you at the minimum penalty level. Making partial payments, even if you can’t pay the full amount, can further reduce accruing penalties. Some penalties can be waived under specific conditions.
In addition to penalties, the IRS applies interest on the total owed tax amount, including any accrued penalties. The interest rate varies based on federal interest rates and is applied daily for each day of delay. If you haven’t filed your tax return, the IRS may estimate your owed amount using a substitute for return, which usually leads to a higher owed amount since it doesn’t consider tax deductions and credits. Penalties and interest charges are then applied to this inflated amount, compounding your owed taxes further.
Imagine you owe $10,000 in taxes, it’s 10 months after the filing deadline, and you haven’t filed your return or paid the tax.
For the first five months, you’re charged a 4.5% failure-to-file penalty of $450 ($10,000 x 4.5%) and a 0.5% failure-to-pay penalty of $50 ($10,000 x 0.5%) each month. This totals $2,500 over the first five months.
Once these first five months have passed, you’re charged the 0.5% failure-to-pay penalty of $50 each month. This totals $250 over the second five months.
After 10 months, your total penalties would be $2,750 ($2,500 + $250). Your total amount owed, including penalties, would be $12,750 ($10,000 + $2,750).
Here’s a table for a visual breakdown of the accrued penalties:
Interest is applied to $12,750—the total of the tax debt plus penalties.The calculations the IRS uses to work out interest are complex and vary depending on particular circumstances. That said, in this example, you’ll likely be paying at least another $300 in interest—taking the total you owe to over $13,000—a 30% increase in your owed amount!
In some cases, you might know you have no tax due. Let’s say your business is pre-revenue, for example. You might think you don’t need to file. In fact, the opposite is true—even if you have a zero-dollar tax return, you still have to file your taxes.
If you don’t owe the IRS money but have missed filing, the good news is that you dodge the 5% failure to file penalties.
The bad news is you’re in danger of losing potential refunds owed to you. If you still haven’t filed your tax return after three years, the IRS withholds your refund, which means you’re no longer eligible to receive it.
We’ve covered what happens if you don’t file taxes—but how can the IRS calculate a taxpayer’s income taxes if they haven’t yet filed their income tax return?
When the IRS is trying to determine how much money you owe them, they file something called a “substitute for return.” They look through all the public information they have on you, including bank account records, records of wages, and any contractor payments made to you by other people. They use these external sources to come up with a number for what you should owe.
The problem is the IRS only uses your recorded revenues to calculate your taxes owed. This makes the calculated number way more than if they included your tax deductions and credits. That’s because tax deductions and credits lower your owed taxes.
What’s worse, the penalties and interest charges are then applied to this inflated owing amount—essentially compounding this inflated amount that you owe.
Helpful resources:
- The Big List of Small Business Tax Deductions
- The Big List of U.S. Small Business Tax Credits
- Tax Credits Versus Tax Deductions
Minimize Interest, Avoid Penalties, and Maximize Savings
You might find yourself in a situation where you owe more tax than you can afford to pay, and this can seem pretty scary. There are several options for moving forward.
However, the best place to start is to file any outstanding tax returns. By doing so, you can accomplish three things:
- Show the IRS you actually owe much less tax than they calculated in their Substitute for Return
- Stop the 5% failure-to-file penalties from building up
- Put yourself in a better position to negotiate with the IRS about your situation
If you need to get years of tax returns sorted out, bookkeeping is the best place to start—it helps you create the necessary records of your income and expenses for those missing years, making it much easier to file your taxes.
Bench’s Retro bookkeeping service completes years of historical bookkeeping, fast. Our dedicated team is here to help out folks in situations just like these.
If you’re interested in receiving help from a specialized team of tax experts to get you caught up and ready to file your back taxes, book a call with a member of our team today.
How the IRS collects unpaid taxes
According to Commissioner Chuck Rettig, the IRS loses as much as $1 trillion every year in unpaid taxes. With losses like these, you can understand why they’re so serious about chasing down outstanding debts.
Before we get into their collection methods, it’s important to know how the IRS communicates: via snail mail. They mail out a wide array of different notices and letters to keep you informed on their actions.
If you’re behind on your taxes, here’s what you might find in your mailbox.
Notices and letters
There are several different notices, and the IRS sends them for a variety of reasons. Each notice or letter will have a corresponding code. Let’s have a look at some examples:
CP2000: The CP2000 is a relatively common notice, telling you the amount of income reported on your tax return doesn’t match up with information the IRS has received from third parties. Check out our CP2000 guide for how to handle this notice.
CP2566: The IRS uses this notice to tell you they haven’t received your tax return, and therefore have calculated your tax, penalties, and interest based on other records they have for your income—like those from your employer or financial institution.
CP504: If you have a tax balance left unpaid, the IRS will eventually send you a CP504 notice. Also known as a ‘Notice of Intent to Levy,’ the CP504 lets you know that IRS collections are beginning, and enforcement tactics will begin if you continue to do nothing.
Letter 1058: If you still continue to do nothing, you could receive Letter 1058 in the mail. This letter is sent by a Revenue Officer rather than the IRS’s automated system. It’s what’s known as a Final Notice of Intent to Levy, and it’s serious stuff. If you fail to respond within 30 days, the IRS has the right to begin aggressive collections proceedings against you.
The IRS sends these letters to encourage you to respond, take action, and pay what you owe. If you happen to disagree with what these notices are telling you, it’s a good idea to take action as soon as possible. If you don’t do anything, the IRS collections division will step in, and their “enforcement tools” can make life pretty difficult.
IRS enforcement tools
Wage garnishments
When the IRS garnishes your wages, they force your employer to pay a percentage of your wages directly to them until the tax debt is paid.
When garnishing your wages, the IRS won’t take everything—they’ll leave enough for you to cover living expenses. But the amount they leave you is based on general standards, not tailored to your specific living circumstances.
When this happens, there is nothing your employer can do. If they don’t comply with the IRS, they risk major fines for their business.
Tax liens
If an assessed tax amount remains unpaid after a series of letters and notices, the IRS can issue what’s called a lien on your business or personal assets.
While the IRS doesn’t actually take anything at this point, a lien means they’re staking their claim of ownership on enough of your assets that would be required to pay back the debt. These assets can include bank accounts, business property, personal property (if you are self-employed and file as a sole prop or a partnership), and other personal assets like cars, boats, and more.
Liens are public record, meaning anyone can see if one is attached to your business. This can make it particularly difficult to secure a loan or investment in your business. Investing in your company is much less appealing if lenders know you have to pay back the IRS before you can pay back your loan.
Tax levies
If liens secure the IRS’s ownership of what you own, levies are the enforcement tool they use to take it.
Once a tax lien has been ignored for long enough, the IRS sends you a “Final Notice of Intent to Levy.” From here, it gets pretty ugly—the IRS can seize property and other personal assets and sell them to pay back your tax debt. They can even take money from your investment or bank accounts.
Levies are the IRS’s last resort: they only use them after plenty of time has elapsed and multiple notices have had no effect. No matter what, it pays to take action on any tax debt long before levies come into play.
Read our guide on tax levies to learn what happens when your assets are levied and how to get them released.
Criminal charges
The IRS handles most tax debt cases using wage garnishments, liens, and levies.
However, if they believe there is clear intent to evade taxes, combined with a failure-to-file, that’s technically a criminal offense. You could end up in court, subject to fines, or even in jail. Cases like these are extremely rare, but they do happen.
Getting help
The IRS takes collecting taxes seriously, so getting ahead of the problem and caught up on your taxes before things get to the collection stage should always be plan A.
At Bench, we have a dedicated team of historical bookkeeping specialists who help business owners get caught up on their taxes, fast. No matter what stage you are in and what notices you’ve received, our team can get to work completing your books so you can easily file your overdue taxes and get in the clear. Book a free call to speak with us and learn how we can get you back on track.
What to do if you can’t pay
If your tax debt isn’t that big, it’s easiest to pay the tax bill in one go and move on.
The thing is, you might not be able to afford that—especially if your tax debt includes several years of accumulated taxes, plus penalties and interest.
If this sounds like you, don’t worry—there are other tax relief options. Let’s talk about what you can do if this applies to you.
1. Installment agreements
If you can’t afford to pay off your debt with one lump sum, the IRS can put you on a short-term or long-term payment plan, sometimes called an “installment agreement.” These plans have you make monthly payments until the debt is fully paid.
Your monthly payment is based on what you can afford. When you apply for an installment agreement, you’re required to provide a clear picture of your financial health, including how much you make each month and your typical monthly expenses. How long the timeline of your payment plan is will determine which type of plan you are on.
Short-term payment plans must be paid back in 180 or fewer days and as a perk come with no setup fees. If the debt cannot be paid back in that timeframe, you must take a long-term payment plan which has setup fees ranging from $31 to $225. For both plans the Failure to Pay Penalty is still charged every month, but is reduced to 0.25% per month once your payment plan is approved.
You can’t apply for a payment plan until you have filed all your outstanding tax returns. This is where bookkeeping comes in handy. Accurate and complete books provide you with the information you need to file your prior years’ tax returns. Bench (that’s us) can do your historical bookkeeping for you. We complete years of books fast, meaning you can get on top of your situation soon. Get started today with a free consultation.
2. Offer in compromise
Sometimes, it’s possible to settle your tax debt with the IRS for much less than what you owe—this is called an “offer in compromise”. If you can show that a payment plan will cause you financial hardship and that you would be unable to pay your tax debt otherwise, you may qualify for this option.
To successfully apply for an offer in compromise, you need to give the IRS an accurate sense of your, or your business’s, ability to pay. This means providing detailed financial statements that show your income, expenses, and relevant assets. You can get these statements from your bookkeeper.
3. Currently not collectible
Finally, you may be granted temporary relief for paying your tax debt. The IRS only grants temporary relief in exceptionally rare circumstances where the debtor can prove their current financial situation doesn’t allow for any payments at all. Similar to an offer in compromise, in order to apply for temporary relief, you’ll need detailed proof of your financial status.
While temporary relief may seem like the preferred option, the IRS will only grant this status until your financial situation improves. It’s not a complete pause on your debt, either: penalties and interest continue to accrue during the relief period until you make re-payment arrangements.
Following this option will likely lead to more debt in the long term.
4. Penalty abatement
As previously covered, in addition to your tax debt, you also accrue penalties and interest.
Luckily, it’s not uncommon for the IRS to waive your penalties.
If it’s your first time owing outstanding amounts to the IRS, you’ve filed all missing returns (or have an extension), and you can demonstrate to the IRS you acted in good faith and your non-compliance was a result of “reasonable cause,” you could qualify for penalty abatement.
The IRS gives a few examples of situations that could constitute “reasonable cause” for failing to file a return or pay tax when due:
- Fire or other natural disasters
- An inability to obtain records
- Death or serious illness, either to you or a member of your immediate family
These are just three examples, but the IRS does make it clear they are open to considering other reasons or situations. You’ll have to demonstrate that you took “business care and prudence” to meet your obligations but were simply unable to do so.
If you want to have your penalties waived, it’s a good idea to have proof of the reason or event that stopped you from filing or paying your taxes.
When the IRS waives your penalties, this also reduces the amount of interest you have to pay (since they calculate interest on a total that includes penalties). So, no penalties mean lower interest: win-win!
Deciding what to do next
There are plenty of strategies and courses of action available to you if you find yourself in arrears with the IRS.
If you’re motivated to do so, have the time, and are confident in your ability to navigate the processes and phone lines, it’s absolutely possible to negotiate and arrange payment with the IRS yourself. You can check out IRS.gov for more specific information.
However, dealing with the IRS can be overwhelming, especially when you’re trying to run your business at the same time.
Here at Bench, we talk to business owners every day, in all types of tax debt situations, who want to get back on track but don’t know where to start. Thankfully, there’s plenty of support out there, but make sure you find the right kind of help for your situation.
Certain professionals, like Enrolled Agents, CPAs, and Tax Attorneys, are allowed to represent you in front of the IRS. These tax experts have the required qualifications to act on your behalf—they’re able to negotiate down your balance, set up payment plans, get penalties waived, and more.
However, the tax resolution industry is also full of unqualified folks who fail to act in their clients’ best interests and sometimes exploit people in challenging situations. It’s not always easy to tell the difference between a legitimate resource and a less trustworthy one, either.
At Bench, we have partnerships with trusted tax resolution professionals and firms across the country. These are experts that we know and trust to do fantastic work with the utmost integrity. If you’re in need of help with a historical tax issue, we’re happy to make an introduction.
The first step
Most often, the reason for falling behind on filing and paying your taxes is not completing your bookkeeping. It’s also the first thing to address when you’re ready to start getting caught up.
To start your resolution with the IRS, you’ll need accurate financial records for your business for each year of missed filings. These financial records, which your bookkeeper generates, are used for your tax returns and will demonstrate how much you can afford to pay the IRS.
This is where Bench comes in. Our specialized historical bookkeepers get your books up-to-date and identify your tax credits and deductions to determine the actual amount you owe the IRS (which, again, could be a lot lower than the amount the IRS thinks you owe).
If you need to negotiate your balance with the IRS or set up a payment plan but don’t want to battle the IRS alone, as a Bench client you’ll have access to our incredible network of partners. We’re happy to connect you with the help you need.
We’re here to get you back on track and ready to move forwards with your life as quickly as possible. Book a call today to speak with our team.
