The first problem with failing to timely file an income tax return is the failure to file penalty. This alone should be an incentive to file your taxes timely even though you cannot fully pay. The failure to file penalty is 5% per month of the taxes due. The maximum failure to file penalty is 25%. Thus, if your taxes are not timely filed, after five months of failing to file, you automatically owe one-fourth more than you originally owed. This works out to be about a 75% annual interest rate after including interest and the failure-to-pay penalty.
But, if you timely file and cannot pay, the IRS will only assert the failure-to-pay penalty, plus interest. The penalty is 1% per month and it is based on the tax owed. However, once you file the IRS is much quicker to start the collections process. But, all things being equal, it is preferable to avoid the very expensive failure to file penalty.
Tax Tip! Always timely file your income taxes or get an extension of time. Extensions are easy to obtain with the filing of Form 4868 by April 15th. The extension is automatic and allows you another six (6) months to file. Thus, legally, most individuals do not have to file their taxes until October 15.
It is important to remember that an extension of time to file your return does not mean you have an extension of time to pay the tax bill, but generally, the filing of an extension means the tax return is not late and the 5% per month failure to file penalty does not apply. The failure to pay penalty will likely apply though.
Suppose you timely file your return, including extension, and you still do not have the money to pay…what are your options? You can ignore the problem; it does take the IRS time to catch up. However, when they do, many times it comes with liens, levies, and asset seizures, or the taxpayer is forced to sell property for less than its fair value to raise cash quickly. Thus, consider the Installment Agreement options.