The clock is ticking, and Tax Day is rapidly approaching whether you want it to or not.
This year, the Internal Revenue Service estimates that it'll handle in the neighborhood of 150 million individually filed tax returns, of which about 80% will be due a federal refund. Based on data from the IRS through Feb. 20, 2015, for last year's returns, the average refund totaled $3,120, which certainly isn't pocket change considering that the average American household earns just a bit over $51,000 annually.
But not all taxpayers manage to get their tax filing or tax payments in before the Tax Day deadline (which you'll note is three days later this year, April 18). What happens to you if you fail to file your taxes or don't pay your taxes in full? Let's take a closer look.
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You're owed money and didn't file
Speaking in general, if you're due a tax refund, then you're usually in the clear in terms of escaping penalties or fines. The federal government gives taxpayers the ability to file their return within three years of the April tax filing deadline in order to collect their owed refund. This would mean you could file a tax return up until April 15, 2019, and still collect a federal refund due for calendar year 2015, or up to Oct. 15, 2019, if you happened to file an extension. Should that three-year period pass, you've effectively given up your right to collect your refund and the government will simply keep the cash for itself.
However, there is one special stipulation for persons who are self-employed. Regardless of whether you're owed money or you owe money, if you fail to file a tax return for longer than a period of three years, you stop receiving any Social Security credits toward your retirement. In effect, your benefit when you retire could be adversely affected.
Late payment versus late filing
On the flip side, if you owe the federal government money and fail to file or pay your taxes, you're very likely to face penalties and interest.
The first thing you need to understand is there are two types of penalties the IRS doles out: the failure-to-file penalty and the failure-to-pay penalty. One is substantially worse than the other, but keep in mind that both can apply to you at the same time.
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Failure to pay
The failure-to-pay penalty merely means you've not satisfied the full amount of taxes you owe the federal government. An example might be filing your tax return on time, but only paying half of the amount you were shown to have owed. In such a case the IRS levies a 0.5% per month fee on the remaining amount owed, with a maximum penalty of 25%,and it also charges interest beginning the day of the due date on the tax return until the date of full payment. The interest rate is determined quarterly by the IRS and is the short-term rate plus 3%, with interest compounded daily.
The IRS will eventually issue a "notice of intent to levy property," and if the amount is still not repaid in full within 10 days following the notice of intent to levy property, the per-month penalty rises to 1% from 0.5%. If, however, you work out an installment program with the IRS, your penalty could fall to 0.25% per month. Generally speaking, efforts on your part to work out an installment plan with the IRS will typically be met with praise and the prospect of reduced penalties.
Note that filing a tax extension on or before Tax Day, but failing to prepay at least 90% of what you're expected to owe the federal government, can result in you facing failure-to-pay penalties. In other words, a tax extension isn't necessarily a penalty-free solution if you owe the federal government.
Failure to file
You might think that failing to file a federal return if you owe the federal government money is a smart move, but it could actually come back to haunt you and your wallet big time.
Failing to file a tax return typically incurs a penalty of 5% per month, or as much as 10 times the per-month penalty associated with failure to pay. Like failure to pay, the maximum penalty will not exceed 25% of your unpaid taxes. However, if you fail to file for more than 60 days after the Tax Day or extension deadline (if you've filed an extension) the IRS will hit you with a minimum penalty of $135 or 100% of your unpaid tax -- whichever is smaller.
Can I get an exception?
Are you wondering if the IRS will be willing to listen to your excuse as to why you didn't pay your taxes on time or file a return? Chances are you probably don't have an excuse that the federal government will accept. However, if you're a citizen or resident alien who's working abroad, if you've suffered through a disaster (examples might include living in an area declared to be a disaster due to a flood or tornado), or if you're a member of the Armed Forces and serving in a combat zone, then the IRS will probably exempt you from traditional Tax Day deadlines.
What are your options?
Obviously, your best bet is always going to be to file your taxes in a timely fashion and pay all taxes owed. Understandably, that may not be possible for everyone. If you find yourself in a financial bind come tax time, still file your return, or request an extension, on time. Failing to file a return, as noted, could result in penalties that pile up very quickly.
Aside from filing your return in a timely manner, consider your options for satisfying what you owe. Understand that the government would much rather work out a payment plan with you than have things escalate into steeper penalties. In other words, don't sweep your problems under the rug. The more proactive you are about paying what you owe, the more the IRS is likely to do to mitigate your penalties. You'll also want to pay as much as you can since interest and penalties will be reduced the closer you can get to the actual amount owed.
Some ideas might be to consider paying a portion of what you owe via credit card, or home equity loan. The lending rate on your credit card or HELOC is probably lower than the combined interest and penalties from the IRS for failing to file and pay. Still, you'll want to keep in mind that you'd be financing one loan with another, which simply pushes your responsibility a bit further down the road.
Other options may include an offer in compromise or a temporary delay in collection. An offer in compromise, or OIC, is an agreed upon payment that's lower than the unpaid tax amount that you and the IRS agree upon to resolve your tax liability. An OIC works only if the IRS agrees to it, and if an installment agreement won't work for you.
A temporary delay in collection can be requested if payment of your taxes would prevent you from meeting your basic living expenses. If the IRS concurs that you can't afford to pay your taxes, a temporary hold on collection may be placed until your financial situation improves. This doesn't resolve your unpaid tax situation, but it affords you the opportunity to ensure your basic living expenses are met.
Hopefully these are situations you'll never need to be acquainted with, but if they do arise, you now understand what to expect and how best to take care of it.
