There's a way you may be able to make more money while in quarantine. By filing old federal income tax returns, you may be able to claim tax refunds you didn't know that you are entitled to.
Written by Lawyer John Coble.
Updated October 1, 2021
The COVID-19 pandemic may have left you with extra time on your hands due to unemployment or fewer hours than you’re usually scheduled at work. Stimulus payments and higher unemployment checks than usual may have helped you survive. There's a way you may be able to make more money while in quarantine. By filing old federal income tax returns, you may be able to claim tax refunds you didn't know that you are entitled to.
Or, by filing old tax returns, you may be able to settle with the Internal Revenue Service (IRS) for less than the full amount of any overdue taxes that you owe the government. When your financial situation is at its worst, you can usually settle with the IRS for a smaller amount than you would ordinarily owe. This article goes into detail about why you should file old federal tax returns, how to prepare and file these returns, and how to resolve any tax debts from previous years.
Why You Should File Your Back Taxes
There are many reasons that you need to file your prior year tax returns. Not the least of which is to avoid additional penalties, interest, and IRS collections enforcement. You only have to worry about these issues if you were legally required to file a tax return during a previous year. You can use this tool on the IRS website to determine whether you were required by the law to file taxes in prior years. Even if you aren't required to file a return, it's a good idea to prepare your return to see if you have a refund due.
Both civil and criminal penalties may be imposed for failure to file your tax return. While criminal prosecution is rarely used, civil penalties are almost always applied. The “failure to file” penalty is 5% for each month that your return isn't filed for up to 5 months. This means you could have a failure to file penalty of 25% of your outstanding taxes owed. There's also a “failure to pay” penalty. It's only 1/2 of 1% per month but it's applied for up to 50 months. That means it can also be as high as 25%. Interest also accrues on your late taxes and the penalties. In fact, interest is even charged on your outstanding accrued interest.
Criminal prosecution is usually reserved for celebrities and large tax debts. The IRS doesn't have the manpower to arrest everyone who fails to file an individual tax return, so it uses these high-profile cases to show all filers what can happen if a return isn't filed. You can be sentenced to up to one year in jail for each unfiled return. There can also be a fine of up to $25,000 per unfiled return. While it is rare that these penalties are enforced, it remains important to file any outstanding tax returns that you haven’t yet turned in.
Statutes Of Limitations
When you haven't filed a return, you leave yourself open to the possibility of an IRS audit at any time in the future. Theoretically, a missed tax filing from 20 years ago could result in taxes being assessed against you. If you filed your return, the IRS would (usually) only have 3 years to audit you or assess new taxes against you. An exception to the 3-year rule exists if you've understated your gross income by more than 25%. In that case, the IRS has 6 years to conduct an audit or a new assessment.
The IRS would then have a 10-year collection period from the tax deadline, date the return was filed, or the date of assessment - whichever is later. Only by filing your return are you able to limit the time the IRS has to collect from you.
IRS Collection Methods
The IRS starts with mild collection efforts. It will send notices in the mail. Those notices will become more threatening if you ignore them.
If the IRS discovers that you should have filed a tax return and you ignore its efforts to get you to file your return, the IRS may file a return for you. This is called a substitute for return (SFR). When the IRS prepares an SFR, it prepares the return in a way that's least advantageous for you. For example, you may have a large mortgage interest deduction and several dependents. On the SFR you'll get the standard deduction and probably only one dependent. But, even after an SFR is completed, you can still file your tax return. The IRS will usually replace the SFR with the return you file and adjust your tax liability for the amount on your return so that the outcome is more advantageous for you.
At some point, the IRS will resort to liens and levies to collect any taxes owed. A lien arises automatically with any unpaid IRS tax debt. This lien gives the IRS a legal claim to your property. It's not a big issue unless the IRS records a notice of federal tax lien in your county's records office. This recorded lien is reported by the credit bureaus. It will hurt your credit score. This is one of the reasons it is so important to file outstanding taxes. Doing so will help you avoid consequences like this one.
Taxpayers fear levies more than anything else. The IRS can take the money you owe right out of your bank accounts. Or, the IRS can use a wage garnishment. Having the IRS take the cash you need to pay bills can leave you in a terrible financial situation. While cash assets such as income and bank accounts are the IRS's favorite things to levy, the IRS can also levy on your other assets. That is, the IRS can seize your cars, business assets, and even your home.
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Steps To Prepare Back Taxes
You have to use the correct tax form for the year you're filing. For example, if you're filing your 2018 taxes, you can’t use the 2020 Form 1040. You’ll have to use the 2018 Form 1040. You can get these old forms through the forms archive on the IRS website. You can also get these older forms through the tax preparation software companies like TurboTax or H&R Block, tax professionals, and any local IRS office.
Once you have the right form, you’ll also need your W-2s and/or 1099s from the old tax years to prepare your return. Most people lose these if they don’t prepare their returns right away. While you can’t get new copies of these documents, you can get an IRS transcript that shows the information from those documents. The easiest way to get your transcript is to use Get Transcript on the IRS website. You can also request your transcript via mail by filing a Form 4506-T.
Preparing Your Tax Return
You can prepare your old tax returns yourself. If you don't feel comfortable preparing your old tax returns, you can hire a tax preparer. Tax preparation for old tax returns can be more expensive than it is for preparing current tax filings. The IRS free help tool provides directories of tax professionals that help financially disadvantaged individuals and the elderly for free. IRS Free File is a directory of free offers for tax software for taxpayers with an adjusted gross income of up to $72,000. There's also tax help for members of the military.
Filing Your Tax Returns
You may think that filing paper returns via certified mail with a return receipt requested is the safest way to file your old tax returns. The good news is that there are less expensive methods that are better for you. Certified mail only provides proof that you mailed "something" to the IRS. It's not proof you mailed your tax return in. On the other hand, e-filing proves that you filed your tax return and when you filed it. You should keep your electronic receipt.
Until recently, you couldn't e-file old tax returns. Now, you can file returns up to 3 years old. You still may have to use a tax software program or tax professional to e-file old tax returns.
Another way to file your old taxes involves going to the local IRS office. When you do this, you should bring a copy of your tax return. Have the copy time-stamped when it is received by the IRS. You need to keep this proof that you filed your return. Don't expect the IRS to make copies for you.
How To Pay Back Taxes
You don’t have to worry about paying back taxes if you have a tax refund due. It's more common than you might think for taxpayers to be surprised by a refund when they file old tax returns. In 2019, the IRS had unclaimed refunds of $1.4 billion.
Sometimes, these surprise refunds are caused by refundable tax credits. These types of tax credits don't require money to be withheld or estimated tax payments to be made for you to be eligible for a refund. These refundable credits include:
The Earned Income Tax Credit (EITC)
The American Opportunity Tax Credit (AOTC)
The Child Tax Credit
Healthcare premiums under the Affordable Care Act
As a general rule, you only have 3 years to file old tax returns to claim a refund. For example, the due date for your 2017 tax return was on April 17, 2018. Since it's now mid-May of 2021, it's more than 3 years after the due date meaning you can’t get a refund for 2017. As with many things, there’s an exception in 2021. The IRS has also extended the deadline for claiming a 2017 tax refund until May 17, 2021.
Ways To Pay The IRS If You Can Afford To Pay
The IRS gives you many different ways to pay. You can mail a check or money order with a 1040-V voucher. You can pay electronically with IRS Direct Pay or the Electronic Federal Tax Payment System (EFTPS). These electronic payments come directly from your bank account. You can pay by credit or debit card through third-party processing companies.
If you don't have a bank account, credit, or debit card, the IRS has convenient ways for you to pay cash. You can pay at the local IRS office, but it's easier to use the PayNearMe retail locations or the Vanilla Direct system. The IRS has information on these retail cash payment methods on this page on the IRS website.
Paying The Old Taxes You Can’t Afford To Pay
You can use the IRS online application tool to propose an agreement to pay your taxes over 120 days. Or, you could pay using an installment agreement up to 72 months. The most common reason people fail to file a return by the tax filing deadline is that they don't have the money to pay by tax day.
While you may not be able to pay the full amount - including tax penalties - even with an installment agreement, you may be able to get a penalty abatement. The IRS has a First Time Penalty abatement program that allows the removal of the penalties in certain circumstances. The IRS will also remove tax penalties for reasonable cause.
Many people can't afford to pay their back taxes with these conventional installment payment arrangements. If these options won’t work for you, you might be a good candidate for a settlement with the IRS. Offers in compromises (OIC) and partial payment installment agreements (PPIA) allow you to settle with the IRS for less than the full amount of your tax bill. An OIC could be paid as a lump sum or over up to 24 months. A PPIA can be paid over time, up to 72 months. However, with a PPIA, the IRS reviews your financial situation every 24 months. After each review, it may adjust your payment amount.
The IRS will take a close look at your financial information before it'll allow either an OIC or a PPIA. The worse your financial information, the better your settlement prospects. For many people, due to COVID-19, 2021 is a great time to show their worst financial situation.
The last choice for tax relief is “currently not collectible” (CNC) status. This isn't as good as the other options because once your financial situation improves, you lose this status. CNC is only a good choice when nothing else will work or if you're certain you'll have a long-term financial problem. If your CNC status exists for the remainder of the time the IRS has to collect from you, the IRS will forgive your tax debt. Remember that the IRS can try to collect from you for up to 10 years from the filing deadline, the date you filed your return, or the assessment date whichever is later. Filing your returns starts the ticking of this clock.
There are many reasons to file your old tax returns. You may avoid more penalties and interest. You'll also remove the possibility of criminal penalties. By filing, you start the statute of limitations that prevents the IRS from continuing to collect from you after 10 years have passed. By not filing, you may miss out on a refund.
If you can't pay, there are several options to settle with the IRS and/or make payment arrangements. But, you can't enter into a settlement or payment arrangement if you haven't filed your returns. Finally, this is a great year to file your old returns. Due to COVID-19 shutdowns, you probably have extra time and your financial situation is probably worse than usual. These facts are helpful when dealing with the IRS.