Big Mistake: Filing Your Tax Return LateTax Planning
Three bad things happen when you file your tax return late.
You can extend your tax return and file during the period of extension; that’s not a late-filed return.
The late-filed return is filed after the last extension expired. That’s what causes the three bad things to happen.
Bad Thing 1
The IRS notices that you filed late or not at all.
Of course, the “I didn’t file at all” people receive the IRS’s “come on down and bring your tax records” letter. In general, the meeting with the IRS about non-filed tax returns does not go well.
For the late filers, the big problem is exposure to an IRS audit. Say you’re in the group that the IRS audits about 3 percent of the time, but you file your tax return late. Your chances of an IRS audit increase significantly, perhaps to 50 percent or higher.
Simply stated, bad thing 1 is this: file late and increase your odds of saying: “Hello, IRS examiner.”
Bad Thing 2
When you file late, you trigger the big 5 percent a month, not to exceed 25 percent of the tax-due penalty.
Here, the bad news is 5 percent a month. The good news (if you want to call it that) is this penalty maxes out at 25 percent.
Example. You are a year late filing and you owe taxes of $10,000; your penalty is $2,500 and it’s not deductible.
Bad Thing 3
Of course, if you owe the “failure to file” penalty, you likely also owe the penalty for “failure to pay.” The failure-topay penalty equals 0.5 percent a month, not to exceed 25 percent of the tax due.
The penalty for failure to pay offsets the penalty for failure to file such that the 5 percent is the maximum penalty during the first five months when both penalties apply.
But once those five months are over, the penalty for failure to pay continues to apply. Thus, you can owe 47.5 percent of the tax due by not filing and not paying (25 percent plus 0.5 percent for the additional 45 months it takes to get to the maximum failure-to-pay penalty of 25 percent).
The government also pours salt into this wound. You get no tax deductions for the penalties.
Another Bad Thing
If you have to pay taxes and penalties for failure to file and failure to pay, you also pay interest on both the overdue taxes and the penalties from the original due date of the return.
If you can show that you had reasonable cause and not willful neglect for filing late, you can avoid the penalties.
But this is not so easy.
In Elick, where late filing was one of several issues, the taxpayers failed to show “reasonable cause without willful neglect” when they claimed that their late filing was caused by waiting for a third party to issue a K-1 they needed to complete their tax return.
The court ruled that the Elicks were responsible for timely filing their returns and that passively waiting for thirdparty information was not a reasonable cause for late filing.5 The court indicated that had the Elicks established that they actively sought the K-1 information or that they were unable to make a reasonable estimate of the tax, it might have ruled differently.
In Lamb, the taxpayers claimed that they relied on their lawyer to prepare and file the tax return. The court noted that even if this were true, it was not a valid excuse for the Lambs’ not filing on time.
What to Do
Foolproof method. File your tax returns on time and ensure that your taxes are paid in full.
Faint-hope method: If you can prove that you exercised ordinary business care and prudence but nevertheless were unable to file the tax return on time, you might escape the penalty, according to IRS regulations.
Don’t get trapped by missing the filing date. If you can’t pay on time, file anyway. This stops that ugly 5 precent a month penalty.
Further, by filing on time, you decrease your odds of an IRS audit.
If you do have a valid excuse for not filing on time, file as soon as you can and plead your case for penalty relief to the IRS.
If you can’t pay on time, consider the IRS installment payment plan.
Key point. Be proactive on this. Don’t let the IRS come to you.