Posted by You should file your federal tax return even if you owe tax and cannot pay it. This is true for a few reasons. The primary reason is that the penalty for filing a federal tax return late is ten times the penalty for paying your tax late. The late-filing penalty is 5% of the amount required to be shown as tax on the return for each month that the return is late. In contrast, the penalty for late payment of tax is .5% (i.e., one-half of 1 %) of the tax shown due on the return for each month that payment is late. Both penalties are capped at 25%.
For example, suppose your federal income tax return shows that you have an unpaid tax liability of $10,000. If you don’t file your return by the due date of April 15 and instead file it two months late, you will owe a late-filing penalty of 10% of the $10,000 tax liability, or $1,000. However, if you file your return on time and pay the tax due two months late, you will owe a late-payment penalty of only 1% of the $10,000 tax liability, or $100. It is much better to file the return on time, even if you cannot pay the tax due right away, to avoid the late-filing penalty. There are other ways to address taxes that you owe and cannot pay, which will be the subject of a future post.
Another reason to file a federal tax return on time even when you cannot pay the tax due is that filing starts the clock on the amount of time the IRS has to assess tax against you for the year. Generally, the IRS has three years from the time the return is filed to assess your tax. (Assessment means that the IRS records the tax on the IRS’s books as a liability that you owe. Assessment is significant because, until the IRS assesses the tax, it cannot use its administrative collection powers.) If you file your return, the three-year period during which the IRS can assess tax starts running. If you delay filing your return, that gives the IRS more time in which to assess the tax and ultimately collect it.