For those of you who have skipped a few years of filing your individual federal income tax returns, the present is always the best time to take care of them. Now that the April 15th crunch time is behind us, today is a great time to meet with a CPA. The goal on delinquent returns is to contact the IRS before they contact you – to keep the ball in your court. Maybe you’re getting married or divorced or entering into a business partnership, and your partner is asking you to take care of your tax baggage. Or you may be wanting to purchase your first home or re-finance an existing one – you are going to need to show copies of those returns.
The penalty for filing late is a late is 5 % per month (that’s right, per month) of your tax due. That penalty maxes out after 5 months, but along with the late payment penalty plus interest, it doesn’t take but a few years before the interest and penalties equal and start to exceed your tax due.
It also appears that if you plan to qualify to buy your mandatory health insurance on an exchange under the new Affordable Care Act, you will be required to file a tax return if you think that your income is low enough to qualify you for a subsidy. The tax return is also where you are charged the additional tax for not carrying health insurance. At present, your income is not verified on the exchange, but it will be cross-checked next year when you renew. So, get ready for some new mail from IRS health insurance enforcement division until you file those late returns. You certainly don’t want to have to pay late filing penalty on the health insurance penalty.
After several warning letters for a particular year that you have not filed, the IRS will send out a notice proposing the tax that you owe for that year. The letter gives you an opportunity to either agree with the tax, or file your own return, by a certain deadline. If you don’t respond within that deadline by preparing and filing your return, the IRS sends a letter called a 90 day notice of deficiency giving you one more chance to file your return before it assesses the tax it has computed. After the 90 days, you have to go to tax court to get the tax changed. This is not the scenario you want to be faced with.
The amount of tax computed by the IRS for you is based on income that you have earned that has been reported to them including wages on W-2 forms, contract labor and royalties on 1099-MISC forms, withdrawals from retirement accounts on 1099-R forms, and sales of stock and investment income from brokerage accounts on 1099-B, 1099-DIV and 1099-INT forms. The IRS computes that tax without any deductions for business expenses, cost of investments sold, or personal itemized deductions. Since none of those deductions have been taken by the IRS, the amount of tax they propose is usually higher than the tax on a tax return prepared accurately by your CPA. In addition, the 3 year statute of limitations never starts running because the IRS filed it instead of you, so it is open to an IRS audit forever, or until you file it yourself. Or, the case may be that the return the
IRS files for you won’t include all of your income since all they are counting is what they know about on your W-2’s and 1099’s, so you may be happy with the tax they figured for you. But remember, your return that is now in their system may substantially understate your income, and if you get audited, there is a penalty for that too – another 20% penalty.
A CPA familiar with your business model will know the most cost-effective ways to get these delinquent returns prepared and filed for you to produce the least amount of tax for the lowest cost. You should end up with a tax return that you could support if it were audited by IRS, not a hastily prepared return that ignores obvious information like deposits to your bank accounts, and other information that is easily obtainable by IRS. One way to look at it is that you should include income that is easy for IRS to find out about. For you musical artists, only an experienced CPA that has spent time in the trenches of the music business will know both what to look for, and what not to waste time and your money on, in order to give you the most bang for your buck. It is a stressful situation, but the stress of not knowing what you owe always goes down once you know what the numbers and the taxes really are.
So, now’s the time to take care of any delinquent tax returns. Don’t wait until you’re faced with deadlines and penalties. We’re tax professionals and we’re here to help.