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What happens if self-employed don't file a tax return?

Stephen Fishman
Tax expert and contributor MileIQ
Adult man working in the office

Not everybody has to file a federal income tax return each year.  For example, you don’t have to file a return if you’re self-employed and earn less than $400 in profit during the year.

Yet, most adults do need to file an annual income tax return each year. What happens if you don’t file a return?  Lots of things. None of them are good.

No penalties if the IRS owes you a refund

There is no penalty for filing late if you’re due a refund. Penalties and interest only accrue on unfiled tax returns if taxes are not paid by April 15. You will have to pay a minimum $210 fine if you file your return more than 60 days late.

If you don’t file a return for the year within three years, you’ll lose your tax refund. The IRS will simply refuse to pay it to you. The same rule applies to a right to claim tax credits such as the Earned Income Credit.

Steep penalties if you owe the IRS taxes

If you owe the IRS taxes and fail to file a return, things get much more serious. First, the IRS charges you a failure-to-file penalty. The penalty is 5% per month on the amount of taxes you owe, to a maximum of 25% after five months.

For example, if you owe the IRS $1,000, you’ll have to pay a $50 penalty each month you don’t file a return, up to a $250 penalty after five months. So, after five months, you’ll owe $1,250.

If you file your return more than 60 days late, you must pay a minimum fine of  $210 or 100% percent of the taxes you owe (whichever is less). This means that if the tax due is $210 or less, the penalty is equal to the tax amount due. If the tax due is more than $210, the penalty is at least $210.

If you have unpaid taxes, you’ll also have to pay a failure-to-pay penalty of 0.5% of your unpaid amount for each month the taxes are not paid. This penalty can be as much as 25% of your unpaid taxes.

If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the IRS reduces the 5% failure-to-file penalty by the amount of the failure-to-pay penalty. Thus, the “good” news is that the IRS can’t assess penalties higher than 25% of the tax due for a particular year.

In addition to penalties, you’ll have to pay the IRS interest on the unpaid tax due. The interest rate is about 3%. This amount can add up quickly, especially for taxes that are several years overdue.

You might be able to persuade the IRS to reduce your penalties. You’ll have to prove you had reasonable cause not file your tax returns. Examples of circumstances that the IRS might consider to be a reasonable cause include:

  • death of a family member
  • mental illness
  • alcoholism or drug addiction
  • bad advice from your accountant
  • extended military service.

For details, see the IRS first-time penalty abatement page.

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You won’t be able to get a loan

If you don’t file a tax return, you’re going to have a lot of trouble buying a home, getting a business loan, or even obtaining financial aid to go to college.

Lenders routinely require that you provide copies of your most recent tax returns to get a loan. No one wants to loan money to someone who can’t be bothered to file a tax return.

You could lose your passport

If you owe the IRS more than $50,000 in back taxes, penalties, and interest, the IRS can have the State Department revoke your passport. If this happens, you won’t be able to leave the country.

You could lose Obamacare tax credits

Do you obtain your health insurance through an Obamacare health care exchange? If so, and you receive tax credits to help pay for your coverage, you must file a tax return. If you don’t, the IRS will require you to repay your tax credits.

The statute of limitations won’t apply

When you don’t file a tax return, the regular rules that protect taxpayers don’t apply. Among the most important of these rules is the statute of limitations.

Ordinarily, if you file your tax return, the IRS has three years to audit you. After that, you’re free and clear and the IRS may no longer question your taxes for that year. Yet, if you omit more than 25% of your income from your return, the IRS has six years to do an audit.

But the statute of limitations does not start until you file your return for the year. In other words, there is no statute of limitations if you fail to file your tax return.

The IRS could file a substitute return

If you don’t file a tax return for a few years, the IRS may file a substitute return for you. When the IRS does this, it calculates your income tax for you, with you filing as a single individual.

As you might expect, when the IRS does this it does not go out of its way to reduce your taxes. It won’t give you credit for all your possible deductions.

The IRS will then send you an assessment letter telling you to file a tax return, agree to the IRS assessment, or explain why you didn’t have to file a tax return.

If the IRS files a substitute return, you should file your own tax return. This way, you can take advantage of any credits and deductions you’re entitled to. The IRS will generally adjust your account to reflect the correct figures.

If you don’t respond to the IRS’s letters, it will commence collection against you. It has many powerful collection tools. For example, the IRS can file a tax lien against you. This will make it impossible for you to sell real property without paying off the lien.

You likely won’t go to jail

One thing you probably don’t have to worry about is going to jail. Failing to pay your past-due taxes is technically a misdemeanor. If you’re prosecuted, you can get jail time up to one year and must pay a fine up to $25,000 for each delinquent tax year.

Yet, the IRS is much more interested in collecting what you owe than sending you to prison. It rarely prosecutes non-filers who voluntarily come forward to fix the problem.

The only likely exceptions are if there are signs of fraud or if you’re a public figure who’s drawn attention to your tax delinquency, a tax protester, drug dealer or involved in organized crime.

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