Tax Law Insights

The United States has a voluntary income tax reporting system. U.S. citizens, permanent residents, and businesses here must annually file income tax returns with the IRS, reporting their "worldwide income," deductions, and their "net taxable income," and pay income taxes to the IRS based on this amount. The rate of tax is "progressive;" that is, it increases as taxable income goes up. There is a minimum level of income for which an annual tax return is not required to be filed and which varies on filing status. For example, in 2016 for a single (unmarried) taxpayer, the individual must generally have at least $10,350 to require a return to be filed for the year. Even if an individual or business has only income they believe may be "exempt" from income tax (e.g. certain social security payments, interest in municipal bonds, etc.), a tax return must still be filed.

Penalties and interest for not filing a required tax return can be substantial and can exceed "credit card rates." None of the penalties or interest owed on a federal tax debt are deductible.

If an individual has received income from third parties, such as wages or salaries (Form W-2) or dividend, interest, property sale proceeds, or contractor payments (Form 1099), the IRS receives this information. If an individual has not filed a tax return reporting this income, the IRS computer system will identify this non-reporting and begin to send a series of notices to the taxpayer notifying them to file. If a return is not then filed, the IRS will prepare a "Substitute for Return" - a default assessment - and then the taxpayer will get a tax notice due bill - and with penalties and interest. A "Substitute for Return," however, is not a voluntary tax return, and the associated tax liability cannot be discharged in bankruptcy.

Finally, not filing a tax return where an individual or business has sufficient income is a crime - "willfully failing to file." Both the IRS and state departments of revenue prosecute taxpayers for not filing. This is about going prison at this point - and, the taxes will also be due. Increased penalties may also apply where not filing is considered to be "fraudulent." Simply not filing a tax return can also be a more serious felony, such as tax evasion, where in addition to not filing, a taxpayer does other "affirmative acts" to evade taxes, such as filing a Form W-4 with his or her employer claiming to be exempt from tax withholding or transferring or hiding assets.

If a tax return is due but has not been filed, care must be taken on how to address the issue. The IRS has a "voluntary disclosure" program that may be uniquely-suited to these situations, and some states offer "tax amnesty" programs for delinquent-filers. An individual with unfiled returns must speak with a tax professional to understand their options.