A Taxing Situation

What happens if you fail to pay your taxes? It’s not good. 

Michael S. Fried, founding member of tax law firm Fried & Rosefelt, has witnessed it many times. Driven by sleepless nights, clients come to him to resolve unpaid tax problems. “The quality of their life deteriorates when they put off solving the problem,” says Fried. “It doesn’t go away.”

Not reporting income does more than affect your quality of life. “Any situation where someone has the intent to evade or cheat and acts in that direction is illegal,” says Scott D. Michel, a tax crimes attorney at Caplin & Drysdale. “If the IRS sees enough badges of fraud and evidence of intent, they can turn it into a criminal case. But even if they don’t, there could be significant—and in some cases catastrophic—financial consequences.” 

Being proactive can help avoid potential prosecution. “The good news is that although failure to file is a crime, the IRS will normally give you a couple of opportunities to pay once they’ve found you or you come forward on your own,” says David S. De Jong, chair of Stein Sperling Bennett De Jong Driscoll’s tax practice group. 

To start, it’s better to file the back year returns than not to file—even if you don’t have the means to make a payment. “Failure to file returns can itself be a criminal offense, and it’s better to get the returns in and deal with the collection side of the IRS,” Michel says. He notes you may qualify for a payment program or extension, but that you should hire a qualified tax preparer and fully disclose your financial situation to receive the proper advice. Being truthful to the tax preparer can guard against future accusations of wrongful conduct if the return is inaccurate.

If you don’t file, you may be tempted to skip the next year—and the next. “At some point, the IRS will most certainly catch up,” De Jong says.

Delinquent taxpayers who come forward should file complete and accurate returns, Michel says. The IRS Fresh Start initiative has a variety of programs to help settle an IRS tax debt and avoid liens. Other tools to help tackle a debt include offers of compromise, installment programs or bankruptcy, Fried says. “There also may be other solutions depending on specific facts and circumstances.”

The IRS’s voluntary disclosure program may provide protection against criminal prosecution, if the disclosure is timely, complete and accurate, and if the taxpayer cooperates with the IRS and pays, or makes a good faith effort to pay the liability. “In a voluntary disclosure, while there can be civil penalties in some circumstances, the amounts of these penalties are often below—and in some cases, far below—what the law would allow the IRS to impose,” Michel says. Consult with an attorney if penalties are involved, he adds.

Also see an attorney if you owe a substantial amount of money. “Installment agreements can generally be obtained online by individuals who owe less than $50,000,” says De Jong. 

If you’re being audited, particularly if there are any issues of unreported income or significantly overstated deductions, it’s best to seek counsel. “Discussions with counsel are protected by attorney-client privilege,” De Jong says. “There is limited privilege between an accountant and a client.” And if you’re contacted by the IRS’s criminal investigation division, he says, “Rush to consult with counsel. When they are involved, it is a serious matter.” 

Of course, the IRS can’t nab every offender, but it can make life very unpleasant for those who are caught, Michel says. “My colleagues and I have seen every kind of tax fraud imaginable in 30-plus years of practice. The U.S. has a remarkable system of voluntary compliance, but some people still are motivated to cheat,” he says. “Aside from being unquestionably illegal, cheating is not worth the hassle, the cost in some cases, or even going to jail. Pay the tax and move on.”