To File or Not to File - That is the Question (or is it?)

As the econcomy continues to struggle and people start to find themselves making decisions on how to allocate their money, it makes sense that sometimes bills might not get taken care of. As a tax accountant, I have seen this firsthand with my client base.

Unfortunately, we are seeing that an increasingly popular way for people to try to save money is to avoid filing their federal income tax returns! While anyone who has wage income doesn't see much benefit from this tactic, self-employed filers and people who have lots of passive (interest, dividend, and capital gain) income can - at least temporarily - keep some cash in their wallet.

This strategy can provide temporary relief, but here are five good reasons for a taxpayer not to skip filing their tax return - even if they can't pay right away:

1. It can land a person in jail
While not paying taxes is a crime, it's only punishable as a civil offense. A taxpayer can (and will) be penalized, but they can't be imprisoned for simply not paying. This isn't the case when a return is not filed or when a fraudulent return is filed. Failure to file a required tax return is punishable as a criminal offense, which means the taxpayer can be put in jail. It's rare to actually see it happen, but Wesley Snipes, Richard Hatch, or Al Capone will tell you that it does happen.

2. The penalties are much higher when someone doesn't file
IRS will charge "failure to pay" penalties and interest on any balance due to them. These penalties vary, but they usually cap out at about 10% of the balance due. However, if someone does not file their return, IRS will also assess a "failure to file" penalty for each month that the return is late, and it is a much steeper penalty. Failure to file penalties can exceed 25% of the actual tax liability!

3. It can limit a person's ability to get credit or government aid
If someone is not current with their tax filings, the IRS will not turn them in to the credit agencies. However, they can still put the taxpayer in a tough spot financially. Virtually every major loan that someone might apply for requires a copy of the last tax return. Applicants must be current on their tax filings to be able to apply for many forms of government aid, including student loans, housing assistance, and many other programs. Having all returns filed is also a condition for people to be able to file for bankruptcy protection.

4. The IRS will not work with anyone unless they are current on their filings
Usually, when people cannot pay, they think they shouldn't file. However, the IRS has several programs available to assist taxpayers in making arrangements to settle their tax liabilities. The IRS offers payment plans, partial settlements, and even deferred payment arrangements to taxpayers. However, these programs all have one thing in common - a taxpayer must be current on their filings and stay current for as much as ten years in order to qualify for relief.

5. Taxpayers could forfeit a refund
In the event that someone's return would have actually shown a refund, they can end up out of luck. IRS rules say that a return must be filed within three years of its due date or any refund that is generated is forfeited. In my practice, I have had several clients who realized that they were unable to claim large refunds from prior years simply because they waited too long to file. There's nothing worse than leaving money on the table - and to the IRS, no less!

I realize that nine out of ten people who read this are going to be current on their tax filings. However, if you are that tenth person, I urge you to get caught up as soon as possible. Not only will you avoid the potential traps listed above, but you just might sleep a little better at night.

--Dan Musick is the tax services partner for Cook & Associates, a full service public accounting firm with offices in San Marcos and San Antonio, Texas.