What Happens If You’re Self-Employed and Never File Taxes?
As a small business owner, sole proprietor, freelancer, or contractor, you are responsible for all of your taxes. As a self-employed individual, you must file an annual return and pay estimated taxes quarterly. Self-employed individuals must normally pay both self-employment (SE) tax and income tax.
But what happens if you fail to file a return or pay a tax bill? If you are required to file a return but fail to do so, you may be subject to IRS penalties. If you wilfully neglect to file a return, you may face further fines and criminal prosecution. Not filing can also affect your personal and business finances.
Want to get caught up with your unfiled taxes today? Then, contact us at The W Tax Group or keep reading for an overview.
Do I Need to File Taxes Self-Employed?
As a self-employed person, you are normally expected to file a yearly return and pay estimated taxes quarterly. If your net earnings from self-employment are $400 or more, you must file a tax return.
Note that net earnings refers to income after expenses. So if your business collects $1,000 in revenue but has $700 in business expenses, you only have $300 in net self-employment income so you don’t need to file.
If your net profits from self-employment were less than $400, you may still need to submit a tax return if you meet any of the following filing requirements:
- You owe any special taxes, including household employment taxes, social security and Medicare tax, and/or alternative minimum tax.
- You (or your spouse if filing jointly) received health savings account (HSA) distributions.
- You had wages of $108.28 or more from a church or qualified church-controlled organization that is exempt from employer social security and Medicare taxes.
- Advance payments of the premium tax credit for health insurance premiums were made for you, your spouse, or a dependent.
What if a Self-Employed Person Doesn’t File Taxes?
If you are required to file a return but fail to do so, you may be subject to penalties. If you wilfully neglect to file a return, you may face further fines and criminal prosecution. Here’s a breakdown of the consequences of not filing taxes when self-employed.
The Failure-to-File Penalty applies if you fail to file your tax return by the due date. The IRS will send you a notice if you owe the penalty.
The Failure-to-File Penalty is based on how late your tax return was filed and the amount of outstanding tax. For each month or part of a month that a tax return is late, the penalty is 5% of the outstanding taxes. The penalty will not be more than 25% of your unpaid taxes.
For example, if you owe $2,000, then the penalty is $100 for the first month. After that, the penalty increases by 5% for every month you haven’t filed. That means if you owe $2000- and two months late filing – the Failure to File Penalty will now be $200.
For tax returns due in 2020, 2021, and 2022, the minimum Failure-to-File Penalty is $435 for returns over 60 days late or 100% of the tax due – whichever is less. For tax returns due in 2023, the minimum Failure-to-File Penalty is $450 for returns over 60 days late, or 100% of the tax is due – whichever is less.
If you do not pay the tax due on your tax return, you will be subject to the Failure-to-Pay Penalty. The penalty you must pay is a percentage of the unpaid taxes. The Failure-to-Pay Penalty is 0.5% of the outstanding taxes for every month or part of a month that the tax is not paid. The penalty will not be more than 25% of your unpaid taxes.
If you receive both a Failure-to-File and a Failure-to-Pay Penalty in the same month, the Failure-to-File Penalty is reduced by the amount of the Failure-to-Pay Penalty for that month – for a total penalty of 5% for each month or part of a month that your return was late. If you haven’t paid after 5 months, the Failure-to-File Penalty will be maxed out, but the Failure-to-Pay penalty will continue until the tax is paid – up to a maximum of 25% of the unpaid tax as of the due date.
For example, if you owe $2,000 and are late filing and paying your return, your estimated IRS penalties will be $10 for the Failure-to-Pay Penalty and $90 for the Failure-to-File Penalty. If you continue to not pay, these penalties will accrue monthly. Then, once the Failure-to-File Penalty reaches 25% of your balance ($500), the Failure-to-Pay penalty will continue accruing until it reaches 25% of your balance.
What If I Don’t File Voluntarily?
The income tax system in the United States is based on the concept of voluntary compliance. This means that taxpayers are responsible for declaring all of their income, correctly calculating their tax liability, and promptly filing a tax return.
So, what happens if you don’t file your self-employed tax return voluntarily? The IRS may file a return on your behalf and then try to collect the money. Here’s a look at the details.
The IRS Files a Substitute Return
If you do not file, the IRS may file a substitute return on your behalf. This form may not give you credit for any deductions or exemptions to which you are entitled. Usually, this leads to a higher-than-necessary tax liability for most people.
The IRS will send you a CP3219N Notice of Deficiency (90-day letter) requesting a tax assessment. You will have 90 days to file your overdue tax return or petition in Tax Court. If neither of these actions is done, the IRS will proceed with its proposed assessment. You cannot request an extension of time to file if you have received notification CP3219N.
Substitute returns are especially rough on self-employed people as they do not include business expenses. As a result, you can not claim expenses and reduce your self-employment revenue and tax liability. For example, let’s say your clients filed 1099-NEC forms with the IRS, totaling $15,000 in business income.
When the IRS reports this income on your substitute tax return, you must pay self-employment tax on the entire amount. However, let’s say that you had to incur $5,000 in business expenses in order to make that money. You can claim these expenses by filing your own tax return, but they will not be included in the substitute return. This means you will be paying more tax than necessary.
Even if the IRS files a substitute return, you should still complete your own tax return to take advantage of any exemptions, credits, and deductions to which you are entitled. In most cases, the IRS will modify your account to reflect the right figures once you file your return.
Collection and Enforcement
The return prepared by the IRS (based on its proposed assessment) will result in a tax bill, which, if unpaid, will initiate the collection process. This can involve steps such as wage or bank account levies or the filing of a notice of federal tax lien.
If you fail to file on multiple occasions, you may face additional enforcement measures, such as increased penalties and/or criminal prosecution.
What Happens if You Don’t Report Self-Employed Income?
Not reporting self-employment is deemed a federal and state felony and is a form of tax evasion. You may face a fee for the amount unpaid, interest charged, and even criminal prosecution.
Self-employment income received through contract payments must be stated on your individual income tax return. A sole proprietorship, for example, must file a company profit or loss tax return, Form Schedule C. Schedule C’s profit or loss information is subsequently transferred to the main page of your personal tax return as positive or negative income.
If you supply services to regular customers throughout the year, such as business-to-business, and earn more than $600, you will receive a 1099-MISC. If you sell through online sites such as Amazon or receive money through a third-party processor such as PayPal, you may receive a 1099-K.
If you receive a Form 1099-MISC, which reports your miscellaneous revenue, or a Form 1099-K, which reports transactions through third parties, the IRS receives this information as well. If you fail to report this and any other taxable income on your tax return, you may subsequently face a penalty.
Self-Employed Tax Evasion
If you fail to file a return or pay any tax owed, you may face consequences for tax evasion – which is a criminal offense.
Failure to file a tax return is considered a misdemeanor, and the most typical consequence is the imposition of civil tax fines against the taxpayer. However, neglecting to file a tax return that was due no more than six years ago can result in criminal tax evasion penalties. If convicted, you could face up to a year in prison and up to $100,000 in fines. Note that jail time for tax evasion is very rare but possible.
Claiming tax deductions or tax credits that you are not entitled to, wilfully underreporting or failing to disclose income, and concealing taxable assets are all examples of tax evasion.
Under IRS legislation, there are two kinds of tax evasion:
- The wilful attempt to evade or defeat the assessment of tax.
- The wilful attempt to evade or defeat the payment of tax.
The most common attempt to evade or defeat a tax is the act of filing a false return that overlooks income and/or claims deductions to which the person is not entitled. This is considered an evasion of assessment.
In contrast, evasion of payment generally occurs after the existence of a tax debt has been established, and it involves an affirmative act of concealment of money or assets from which the tax could be paid. For example, filing bankruptcy with the intention to prevent or delay IRS collection efforts.
Tax Evasion vs. Tax Avoidance
Tax avoidance is the lawful means to minimize taxable income or tax owing. For example, as a small business or sole proprietor, you can take action to reduce your tax bill by claiming allowable deductions and credits or by investing in tax-advantaged accounts such as IRAs.
Tax evasion, however, is a type of tax fraud in which illegal means are used to conceal income or information from the IRS or other tax authorities in order to avoid tax assessment or payment.
The difference between tax evasion and tax avoidance is essentially defined by two factors: lying and hiding.
For example, investing in a 401(k) or making a tax-deductible donation are both legal ways to reduce your tax bill. However, concealing assets, income, or information in order to avoid tax liability is not.
Spies Evasion for Non-Filed Tax Returns
Passive failure to file tax returns does not constitute tax evasion. An evasion case can only be established if the taxpayer engaged in an affirmative act to hide details or mislead the tax authorities. Failure to file a return combined with an affirmative act of evasion is known as “Spies evasion.”
Examples of Spies evasion include:
- Keeping two sets of books.
- Making incorrect or changed entries.
- Falsifying bills.
- Destroying records.
- Hiding income sources.
- Handling transactions in order to avoid keeping traditional records.
- Any other behavior that has the potential to conceal or deceive.
For example, if you keep one set of records that accurately depicts the business, and a second false set of records that is purposely inaccurate – coupled with unfiled tax returns – that constitutes as Spies evasion.
Consequences of Tax Evasion
An unintentional error on your tax return does not automatically make you a tax evader; intent is a factor. If you did attempt to dodge taxes, here are some of the penalties you could face:
- A felony on your record.
- Up to 5 years in prison.
- A fine of up to $250,000 for sole proprietors (or $500,000 in the case of corporations).
- A charge for the cost of your prosecution.
Filing Past-Due Returns
It’s good practice to file all tax returns that are due, whether or not you can pay in full. You can file your past-due tax returns the same way and same location as you would file an on-time return. If you have received a notice, make sure to send your past-due return to the address specified on the notice.
Filing past-due returns minimizes the risk of facing IRS penalties, allows you to report your costs and deductions accurately, and limits any interest charges that have occurred.
Other Consequences of Not Filing Returns When Self-Employed
In addition to the consequences doled out by the IRS, you may also suffer other personal and business consequences.
Financial Consequences for Your Business
If you don’t file tax returns for your business, lenders generally won’t be willing to loan your business money. They rely on business tax returns to see how your business is doing. Investors may also want to see old tax returns, and if you decide to sell your business, it will be nearly impossible without a history of tax returns showing your profits.
Additionally, if you don’t file state tax returns related to your business, you risk being shut down. Many states rescind business licenses for businesses that don’t file sales tax returns, for example.
Personal Financial Consequences
If you’re self-employed and you don’t file, you will also struggle to get loans for yourself. In particular, mortgage lenders rely on tax returns to verify self-employment income.
Additionally, if you are self-employed and fail to file your federal income tax return, any self-employment income you generate will not be reported to the Social Security Administration. This means that you will not be eligible for Social Security retirement, death, or disability benefits. Filing your past-due return reduces the risk of losing out on such benefits.
How Do I Make Quarterly Payments?
Because you do not have an employer who withholds Social Security and Medicare taxes and income tax, you must pay estimated taxes every quarter. You can mail estimated tax payments with Form 1040-ES, or you can pay online, by phone, or using the IRS2Go app on your mobile device. You can also make estimated tax payments online, where you can view your payment history and other tax documents.
How Do I File My Annual Return?
To file your annual tax return, you must use Schedule C to declare your income or loss from a business you ran or a profession you practiced as a sole proprietor. If you have a partnership or an S-corp, you need to file a standalone partnership or corporate return. Then, you will report your business income on your individual tax return. To report your Social Security and Medicare taxes, you must complete Schedule SE (Form 1040 or 1040-SR), Self-Employment Tax.
What if I Can’t Pay My Tax Bill?
You may be eligible to set up a self-service, online payment plan that allows you to pay off a debt over time. After submitting your online application, you will be notified whether your payment plan has been approved without having to contact or write to the IRS. Even if the new tax has not yet been assessed, online payment plans are handled faster than requests presented with electronically filed tax returns.
Get Help Filing Self-Employed Tax Returns
If you are self-employed and have earned a net profit of over $400, you are required to file a tax return. Failure to file can lead to IRS penalties, interest, and, in some circumstances, legal prosecution. Furthermore, you may be committing tax evasion if you take actions to avoid paying tax wilfully, coupled with not filing returns.
Don’t panic. Remember, failure to file tax returns does not constitute tax evasion. This only applies in rare situations where someone is trying to avoid paying taxes. In most cases, you can get caught up by filing the last six years of returns, and once you’ve filed everything, you should be able to set up a payment plan or apply for relief options.
Need help? If you need help with unfiled returns or need advice regarding an unpaid tax bill, call the qualified team at The W Tax Group at 77-500-4930 for a free consultation and the answers you need.