A recent, high profile tax case has been all over the news. Actor Wesley Snipes was sentenced to three years in federal prison last week on misdemeanor charges of willfully failing to file tax returns. While he was also charged with tax evasion, he was not convicted on those charges.
Now, just for the record, my intention here is not to weight the merits of the case against Wesley Snipes, nor get into the discussion about the legitimacy of the government's tax authority or lack thereof. My intention here is to simply explain how to avoid a similar fate yourself.
So, what exactly IS "willful failure to file a tax return", and why does the IRS consider this to be such an egregious error?
First, one needs to understand the mission of the IRS. The IRS mission statement is to "provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all." I want to put emphasis on the "meet their tax responsibilities part". Whether you think you have a "responsibility" to pay taxes or not, the government thinks you do, and they've tasked the IRS without collecting that tax.
What does this have to do with filing tax returns? It's pretty simple, actually. In order for the IRS to collect taxes from you, they have to know HOW MUCH to collect. If there's no dollar figure for them to go on, they're pretty much in the dark. A tax return provides this number. Not only that, but a tax return includes your most recent address and perhaps even your phone number, so it provides contact information to the IRS for how to reach you in order to collect said tax.
Since the IRS collects the vast majority of the information that they need in order to do THEIR jobs via tax returns, they consider the filing of those tax returns to be one of YOUR biggest responsibilities in this whole process. In fact, it's considered so important that the penalties for failing to file a tax return on time are the steepest penalties that the IRS charges. This penalty is 5% of the balance due per month or fraction of a month, with a 25% cap. On top of that, the IRS is going to charge you interest not only on the principal, but also on all penalties. So, the failure to file penalty, plus interest, can really add up quickly, and can do so in less than 6 months.
Compare the failure to file penalty with the other common penalty for individual income tax payers: the failure to pay penalty. This penalty is "only" one half of one percent per month, and also has a 25% cap. Note that it takes 50 months to max out this penalty, whereas it only takes 5 months to max out the failure to file penalty.
Now, what happens if you don't file your tax returns? We work with clients all the time that haven't filed tax returns in years and years, sometimes even decades. In the majority of cases, the IRS doesn't pursue criminal charges on these individuals, unless the circumstances are such that the taxpayer is blatantly and purposefully refusing to comply with the law, which is apparently what got Wesley Snipes into such hot water.
Most of the time, the IRS will file a return on your behalf, called a Substitute For Return, or SFR. This tends to be a bad thing, since the IRS knows nothing about your dependent exemptions, may not know your current marital status, and has no records of your medical expenses, charitable donations, or any of the other hundreds of other legitimate tax deductions you might otherwise be eligible for. This means that they take the income information provided to them by employers, banks, pension companies, etc., and use that as the basis for preparing a tax return. At best, the only deductions you'll get are the standard deduction and one personal exemption, and nothing more. Also, they will tax you at the highest tax rate for whatever income they have record of. As you can see, having the IRS file your tax return for you is a very BAD IDEA.
There are a lot of people that don't file tax returns because they know that they are going to owe. They think that simply not filing means that the tax won't get assessed against them, which isn't true. Once an SFR is filed, the penalties and interest are then calculated based on when the return SHOULD HAVE BEEN FILED, not when the SFR was done. That means that years worth of penalties and interest could already have accrued, which can easily double your tax bill.
So, the lesson to be learned here is that, even if you haven't filed tax returns in years, it's better to take the time to get caught up, because just about any tax return you file is going to be better than what the IRS comes up with. Also, if you file the return on your own, you're looked at much more favorably in the eyes of almost any Revenue Officer (i.e., "collections guy") that gets assigned to your case, and demonstrates a willingness to play ball with the IRS and work towards a satisfactory resolution of the situation.
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