Although it’s extremely rare to go to jail for not paying taxes, it does happen. It was tax evasion, after all, that ultimately sent notorious gangster Al Capone to prison.
Expensive penalties and interest are the most common consequences of not paying your taxes. However, if your tax bill is large and you’re not cooperating with the IRS to pay it, you could face more unpleasant—and public—consequences.
Penalties for Failing to File Your Taxes
If you’re struggling financially and can’t pay your taxes, you might think you can postpone the inevitable by not filing a return. Unfortunately, the IRS doesn’t work that way.
If you don’t file a tax return by the filing deadline for a particular year, the IRS will assess a failure-to-file or delinquency penalty of 5% of your outstanding tax liability per month. In the second month, they tack on an additional $435 penalty (or remaining tax liability, whichever is less).
You’ll be charged 5% per month for up to five months, for a maximum penalty of 22.5% of your outstanding tax liability.
The failure-to-file penalty is just the beginning, however. You’ll also be charged interest on the penalty, the outstanding tax liability, and any unpaid interest. The IRS charges 3% plus the current federal short-term interest rate. If the short-term rate is 3%, you’ll pay 6% on your debt. It’s easy to see how things can quickly snowball out of control.
Is there a statute of limitations on filing your taxes?
There’s a 10-year statute of limitations on collecting unpaid taxes but no such limit applies to filing your taxes. Don’t try to wait out the IRS, they can pursue you even to death to collect delinquency penalties.
Just ask professional executors and estate attorneys. If you have unfiled tax returns when you die, your executor will have to file them and pay any back taxes, penalties, and interest before your estate can be distributed to your heirs.
Don’t forget state and local taxes
States typically follow federal tax filing deadlines but they have their own failure-to-file laws. Many follow the federal formula of 5% per month to a maximum of 22.5% of outstanding tax liability. Of course, you’ll likely pay interest on your state and local delinquency penalties, too.
Penalties for Not Paying Your Taxes
If you file a return but don’t pay your taxes by the deadline, the cascade of consequences generally starts with—you guessed it—a penalty. The failure to pay penalty is 0.5% per month up to a maximum of 25% of your unpaid balance. In total, the IRS can charge a maximum of 47.5% in combined delinquency and late payment penalties.
As you’d imagine, interest accrues immediately on unpaid taxes, as well. If the current interest rate is 5%, you’ll pay $5 per month for every $1,000 in outstanding taxes and penalties.
If the IRS is slow about answering its customer service line, it’s on top of its game when it comes to sending demand notices. Whatever you do, don’t ignore an official IRS notice. If you don’t respond within the specified timeframe, the notice is a gateway to further action.
7 things the IRS can do if you don’t pay your taxes
Ignore your notice and you can expect one or more of the following consequences:
- Forfeit of future refunds: If you have unpaid taxes from a prior year, the IRS can use any future refunds to pay the balance. Keep in my, that includes all penalties and interest, not just the outstanding tax liability.
- Federal tax lien: The IRS can file a claim against current and future assets, including your home and your car. This will turn up on your credit report and ding your credit score, affecting your ability to get a mortgage or rent a home.
- Deny your passport: If your tax debt exceeds $54,000 in 2021, the IRS can forward the information to the State Department. The State Department can refuse to issue a passport or renew your existing one.
- Refer to outside collections: The IRS can refer your unpaid balance to an outside collection agency. This may not sound like the worst possible consequence but collection agencies tend to be far more persistent, aggressive, and intrusive than IRS agents, believe it or not.
- Tax levy: A tax lien is a claim on assets; the levy is the enforcement of that claim. The IRS can seize your bank account as well as your home, car, boat, and any other property you may own, and sell them to satisfy your debt. They can also seize any state tax refund you’re owed. Don’t think you’re off the hook if you don’t own anything—the IRS can go to your employer and garnish a significant portion of your paycheck. Not even Social Security benefits are out of reach of the IRS.
- Summoned to appear: A summons is a legal notice to appear before an IRS representative with records and documentation. You may be asked to testify under oath. In some cases, the IRS summons third parties such as your bank or accountant.
- Criminal charges: While this is an extremely rare event, jail time is a potential consequence of failing to pay your taxes. The good news is the IRS reserves criminal charges for cases of intentional fraud and exceptionally large balances—think hundreds of thousands or even millions of dollars in unpaid taxes.
Keep in mind, state revenue departments have all the same tools in their collections arsenal (minus the State Department assistance). If you owe both state and federal back taxes and you’re not making a sincere effort to pay them off, you could be in for a world of hurt.
What Should I Do If I Can’t Pay My Taxes?
In 2020, nearly 8 million filers owed taxes on their tax returns. If you can’t pay your taxes on the tax deadline, you’re hardly alone.
If that’s you this year, here’s what you should do to minimize the consequences.
1. File a return by the deadline
Don’t compound your tax consequences with a delinquency penalty. Even if you can’t pay your taxes, make sure your return is filed by the tax deadline (April 15th).
A quick reminder: Filing an extension doesn’t absolve you of your obligation to pay your taxes by April 15th. An extension is simply permission to file your return late, not pay your taxes late.
2. Pay as much as you can
Even if you can’t pay your taxes in full, you should send as much as possible with your return. Your penalties and interest payments will be lower if you make a partial payment.
Now is the time to look at every possible option for paying your tax bill. If you can pay it off in under a year, consider opening a credit card with a 0% introductory rate and paying your taxes that way.
If your liability is larger, you may be better off tapping your home equity or taking out a personal loan. For some people, borrowing against a 401(k) may be an option.
If you’re borrowing to pay your tax bill, do the math to make sure your interest and finance charges aren’t higher than your IRS penalties and interest. Talk to your tax preparer if you need help weighing your options.
3. Continue to pay as much as you can
There is a lag between the tax deadline and the date you receive a demand notice from the IRS. Don’t just wait anxiously for the letter to show up in the mail. Send in as much as you can in the meantime. Every dollar you pay now lowers your penalties and interest later.
4. Be proactive with the IRS
The IRS is primarily interested in collecting taxes, not punishing taxpayers. Contact the IRS as soon as you know you can’t pay your bill in full. Depending on your financial situation and the amount you owe, you may be able to negotiate an offer in compromise (OIC).
If the IRS accepts an offer in compromise, it essentially agrees to accept an amount less than you owe as payment in full for your back taxes and penalties. While these are usually reserved for lower-income filers, the IRS considers all OICs submitted by qualifying taxpayers.
You can use the Treasury Department’s OIC pre-qualifier tool to see if you might be eligible.
If an offer in compromise isn’t possible, try to arrange a monthly payment plan. Depending on your balance, the IRS can extend payment plans for up to 72 months. Penalties and interest still accrue, but you avoid any further collection or enforcement action.
You can check your eligibility for a payment plan and apply online on the IRS website.
5. Bankruptcy as a Last Resort
For some people, unpaid taxes become an insurmountable debt. If you’ve tried every possible way to get out from under unpaid taxes, you may be able to discharge the debt with Chapter 7 bankruptcy.
Bankruptcy isn’t a sure-fire solution, however. It only erases tax debt that is more than three years old. Bankruptcy also can’t clear an IRS lien. If the IRS files a lien against your home, for example, before you file bankruptcy, you’ll have to pay it off before you can sell.
If you’re considering bankruptcy because you didn’t pay taxes, truthfully disclose everything to your attorney before deciding to file. You have to meet several conditions before you can discharge your tax debt with bankruptcy. Your attorney needs all the details to determine whether your taxes can be discharged.
6. Contact a professional
Most people don’t intentionally underpay their taxes or skip paying them entirely. Unless there’s an unavoidable hardship—job loss, illness, or death, for example—people generally assume their employer withholding or estimated quarterly tax payments are correct.
If you’re faced with an unpayable tax bill this year, contact a tax professional right away to figure out what went wrong. If your income went up or your dependents went down, you may need to adjust your withholding.
On the other hand, your tax pro may find ways to lower your tax liability with qualifying IRA or HSA contributions, tax credits, tax-advantaged investments, or other strategies. Whatever you do, find the source of the problem now so you don’t continue to rack up unpaid tax debt year after year.
