My state doesn't have a state income tax. That would add a level of complexity to filing back taxes.
Every year, about this time, the “income tax is illegal” protesters start chiming in. Hopefully you aren’t buying in to their claims, since, as far as I can tell, every tax protester has been found guilty in court and required to pay back taxes. Every argument they’ve come up with has been found invalid; the IRS knows their rules better than you do. But suppose you aren’t trying to do the civil protest thing, maybe you just forgot, or were under the misconception that not owing anything means you don’t have to file. Regardless of the intent, the initial response of the IRS is pretty consistent. I’ll walk you through what I’ve learned from helping a friend go through this.
Disclaimer: I am not a tax professional. This narrative relates my experience only.
How it usually goes.....
You miss the filing deadline
Once April 15th has passed, you start to accrue penalties. Yes, they start the day you are late and continue to accrue until you file. There are two separate penalties; one for not filing, and one on the tax you should have paid (I think they call this “interest”, but it may as well be a penalty). Note that the penalties are calculated separately, so even if you don’t owe taxes, you will still pay a penalty. The penalties are a little confusing to figure out, but plan on 5% a month based on what the IRS thinks you should have paid. The key thing to remember here is that the penalties are not minor.
You continue not to file
The IRS will be sending you delightful little notes reminding you that you need to file your tax return. If you somehow manage to ignore these for long enough, the IRS will fill out your tax form for you. Great! You say!, No. Not great. They fill out the form based on your income and any taxes you had deducted. They don’t put in any deductions other than the standard. If you had mortgage, charity, etc deductions they aren’t on the proxy form. Any stocks you sold are included as income, without the basis subtracted. Bottom line, the IRS isn’t doing you any favors by filling out the proxy form. The good thing is that the failure to file penalties stop, the bad thing is that you’re still accruing interest on what they think you owe them.
You continue to ignore the IRS
The IRS will continue to send you notices. At some point the notice will change from “you owe us this much” to “we have levied your bank account for the amount you owe us”. That last phrase could be “put a lien on your house”, “are garnishing your wages” or any other very scary thing. For most people, this is the point at which the whole thing becomes very real, and they realize that ignoring the IRS was perhaps not the best idea. Now what do you do?
You have to deal with it
This is the stage in our little conversation where most people will tell you to go find a tax professional. Don’t throw that idea away just yet, but I’m going to tell you that the first thing you should do is head down to your local IRS office and talk to them. They know tax law very well, they deal with failure-to-file issues all the time, and they have all of your income information. They are also very helpful. In all likelihood, the first thing they’ll tell you to do is file all of your back taxes. You want to do this as soon as you possibly can. Before you leave, get a printout of all of your income/tax information that the IRS has. They are happy to provide you with this.
You need to file your taxes now
You’ll stop accruing penalties on any failure-to-file years for which the IRS has not yet filed a proxy form. If you also pay what you owe, or make arrangements to start paying it, you’ll stop accruing penalties on the money you owe. You will get a separate bill for the interest and penalties (probably months later).
But it is messy
Filing your back taxes is a pain in the behind. You might consider a professional now, but I did seven years of back taxes for someone using the tax software available for each of those years. I’m not trying to sell you on TurboTax, since probably any good tax software will be just as helpful, but using TurboTax I dealt with divorce, house sale and stock sales. It walked me through everything. The real key is to make sure you’re using the correct software for the proper year. Get house sale information from government websites, get stock information from your broker’s website. You can also go to offices in person and get printouts. Even if you choose to use a professional you’ll need all the information you can get about the years for which you need to file. Keep in mind that any refund you might have gotten for any of those past years is gone. Forever. The import functions for the software didn’t work and I had to enter everything by hand, a royal pain for the stocks, let me tell you, but completely doable.
By doing it myself, it’s possible I missed a few dollars here and there, but by filing quickly I stopped all the penalties, and prevented the levy from going through. I also saved whatever money we would have paid to a professional. We took the tax forms back to the local IRS office. They stamped them with the date, and verified that they had received the forms. This is a much better plan than mailing the forms in – it’s faster, and you know they got them.
You will wade through plenty of red tape
Once the IRS has your forms, they will go through them individually and replace each proxy form with the form that you filed. Then they calculate the fees that you owe. This can take months, and while you’re waiting you might continue to get demands for payment from the IRS. It’s OK, it’s an automated thing and they can’t stop it until they’ve processed all your forms. Just call, or go to your IRS office and tell them you filed and on which date. They’ll look you up to verify that your tax forms were received, and put a delay on the payment demand.
Eventually you’ll get the bill for the penalties (we filed in October and we’re still waiting). There are ways to request leniency, but I haven’t gotten there yet. I promise to update you when the time comes.