What Happens If You’re Self-Employed and Never Filed Taxes?
The IRS holds self-employed people to a high standard when it comes to filing taxes — as business owners, there is an assumed level of sophistication when it comes to tax and financial matters.
For example, while W-2 employees have their taxes withheld for them from their paychecks, the IRS expects self-employed individuals to pay in the taxes they owe quarterly.
Therefore, understanding your estimated tax obligations as well as your other obligations as a self-employed person under the tax code — in addition to the consequences you could face for failing to meet these obligations — is fundamentally necessary to your business success.
Your Tax Obligations As a Self-Employed Person
Making Estimated Tax Payments
Most self-employed people must make quarterly estimated tax payments to avoid being hit with the underpayment of estimated tax penalty.
If you expect to owe at least $1,000 in taxes for the year after subtracting any withholding and refundable credits, you will generally need to pay estimated taxes.
These payments are due four times per year — April 15, June 15, September 15, and January 15 of the following year — though the deadline will move to the next weekday if it falls on a weekend or holiday.
You can determine your quarterly payments in one of two ways: by paying an amount equal to 100% of the prior year’s total tax liability (110% if your adjusted gross income was more than $150,000) or by paying at least 90% of your current year’s tax liability.
You may also calculate the payments each quarter based on your actual income for that period.
It is important to remember that these payments must cover both your income tax and your self-employment tax obligations.
Filing Returns on Time
Meeting tax filing deadlines is one of the most important steps in maintaining compliance.
For most self-employed individuals, the deadline to file is April 15, though you may request an extension to October 15 if you need additional time to prepare your return.
If you’ve made an S corporation election for your LLC or corporation to be taxed as an S corporation, or if your business is a partnership for income tax purposes, the deadline for your business tax return is actually March 15, though your individual return is still due on April 15.
Extensions may be requested for business returns as well as individual returns.
An extension to file, however, does not extend the time you have to pay any taxes due.
The failure-to-file penalty is steep at five percent of the unpaid taxes for each month the return is late, up to a maximum of 25%, and it can add up quickly.
Filing late also shortens the time you have to claim refunds or tax credits, which is generally limited to three years from the original filing deadline.
Paying What You Owe By the Due Date
Filing on time is only part of staying compliant with your tax obligations; paying what you owe by the due date is equally important.
If you cannot pay your full balance by the deadline (or extended deadline, if you requested an extension), you should still file your return on time to avoid the failure-to-file penalty, which is significantly higher than the failure-to-pay penalty.
Once your return is filed, you can explore payment options such as a short-term payment plan of up to 180 days, a long-term installment agreement, or, in certain circumstances, a hardship-based resolution such as placement into currently not collectible (CNC) status or an offer in compromise.
Even with a payment arrangement in place, interest and penalties will continue to accrue until your balance is paid in full, so if you intend to fully pay off your balance anyway, you will save on interest and potentially penalties if you pay your balance off as early as possible.
Paying Yourself a Reasonable Wage (S Corporations Only)
As more and more businesses elect to be taxed as an S corporation for income tax purposes, more and more businesses are finding themselves out of compliance with paying themselves a reasonable wage amount for the services they perform as an employee of their own S corporation.
Fundamentally, if your business operates as an S corporation and you perform substantial work in the business, the IRS requires that you pay yourself a reasonable wage for your services, i.e., you cannot simply designate all payments you receive from your S corporation as distributions.
Why does the IRS care? They care because wages are subject to payroll taxes, while distributions are not, creating an incentive for some S corporation owners to minimize wages and take more income as distributions.
What constitutes a reasonable wage depends on factors such as industry standards, the nature of your duties, the amount of time you spend working, and the profitability of the business.
7 Consequences of Never Filing Taxes As a Self-Employed Person
If you’re self-employed and never filed taxes, here are seven things that could happen to you, from least concerning to most concerning.
However, there is something you can do — you can get right and file your required returns (or at least the returns that are in your best interest to file).
1. Nothing
Truth be told, it’s completely possible that nothing will happen to you if you’re self-employed and never filed taxes.
This is especially true if your income is not reported to the IRS on forms like a W-2 or a 1099.
Now, don’t get me wrong — even if your business is cash based and none of your income is reported to the IRS, you should still file your tax return; this is the law, and it is a federal crime to willfully fail to file a required tax return.
However — and this may change in the future — but for now, it’s quite unlikely that the IRS will be able to hunt you down for your unreported income and unfiled taxes without at least some tax documents being filed in your name.
2. Loss of Refunds
While it’s not likely unless you made estimated tax payments during the year, it is conceivable that you may be due a refund for one, some, or all of the years for which you’ve been self-employed and never filed taxes.
This could be due to, for example, you being eligible for credits like the earned income tax credit or other refundable tax credits that can eliminate your self-employment tax liability and even put cash back in your pocket in the form of a refund.
However, there is a three-year time limit on how soon you have to file a tax return after its deadline in order to actually get your refund from the IRS!
3. Inability to Obtain Financing
Not filing your tax returns could make it more difficult for you to take out loans.
If you’ve ever taken out a mortgage, you know that lenders often want to see at least two years of tax returns.
That said, it is possible to get financing as a business owner without submitting tax returns; there are lenders still around who will do bank statement loans, but this is a bit rarer, and you may be looking at a higher interest rate.
4. Loss of Social Security Benefits
So if you know anything about Social Security, you know that if you were born after 1928, you need 40 credits to qualify for Social Security benefits.
As long as you make a minimum amount of money during the year through wages or self-employment income, you are awarded up to four credits for the year.
Right now, that amount is about $1,500 per credit, so if you earned at least $6,000 during the year in wages or self-employment income, you will get the maximum four credits during the year.
Now, if you were an employee and your employer properly reported your wages and all that to the government, then the Social Security administration knows you were working and will give you credits for that year.
But what if you’re self-employed and you never file a tax return? Well, then you won’t accumulate any Social Security credits based on that income if you don’t report those earnings within three years, three months, and 15 days of the end of the year in which you earned that self-employment income.
So the credit calculation is just to qualify for Social Security benefits; but the amount of benefits you receive is based in part on an indexed calculation of your actual earnings. And obviously if your earnings aren’t reported to the government, your benefits may be lower.
5. Substitute for Return Preparation
If your self-employment income is reported to you on a 1099, there’s a good chance — and the chance is higher the bigger the numbers on your 1099s are — that the IRS will prepare a tax return for you.
These IRS-prepared returns are called substitutes for return (or SFRs).
And the rough thing about SFRs for business owners is that when the IRS prepares an SFR for you, it does not give you any business deductions; this SFR will calculate your tax liability essentially based on your gross receipts.
For example, let’s say you gross $200,000 in your business, but you have $150,000 of business expenses, meaning you netted $50,000 in your business.
If you filed your own tax return, you would report all those $150,000 of expenses, and your tax liability would be based on the $50,000.
However, in an IRS SFR situation, your tax liability would be based on the $200,000 gross.
And why does the IRS prepare SFRs for taxpayers?
They do so so that they can assess a tax liability against you and eventually take forced collection activity against you through things like wage garnishments and bank levies.
6. Identity Theft
If you don’t file a tax return in your name and Social Security number, somebody else might.
This isn’t super common, but it does happen.
And you can prevent this by actually filing your own tax return because if you file your tax return and then somebody else attempts to file a tax return for that year with your name and Social Security number, that return will be rejected.
7. Federal Prison
Yes, you can go to federal prison for not filing your taxes; it is technically a federal crime.
Section 7203 of the Internal Revenue Code says:
Any person required under this title to pay any estimated tax or tax, or required by this title or by regulations made under authority thereof to make a return, keep any records, or supply any information, who willfully fails to pay such estimated tax or tax, make such return, keep such records, or supply such information, at the time or times required by law or regulations, shall, in addition to other penalties provided by law, be guilty of a misdemeanor and, upon conviction thereof, shall be fined not more than $25,000 ($100,000 in the case of a corporation), or imprisoned not more than 1 year, or both, together with the costs of prosecution.
So there you have it — you could be imprisoned up to one year for failing to file a tax return.
That said, the government isn’t going out and arresting and prosecuting everyday folks who got behind on filing and paying their taxes.
It’s not like a warrant is automatically issued for everybody who was supposed to file a return but didn’t; it doesn’t work like that.
Don’t get me wrong — the individual where life got in the way and they simply got behind on paying and filing will still likely, if they have a tax liability, be looking at significant penalties and interest for their unfiled tax returns, but they probably don’t have to worry about criminal investigation.
However, an individual who has other shady stuff going on with their tax situation could very well be a ripe target for the IRS Criminal Investigation Division.
Yes, the IRS has a Criminal Investigation Division — referred to as C.I. — that is comprised of armed and badged federal law enforcement officers called Special Agents, and if you have an accounting background but you’re also interested in law enforcement, they’re actually hiring.
And these IRS Special Agents arrest people for federal tax crimes along with other specific forms of federal financial crimes such as money laundering.
I’ll probably do a separate article on how the IRS Criminal Investigation process works, but for now let me just say that it is a very manual process generally involving either a tip from the public or from an IRS auditor (a revenue agent), and then it has to go up two levels up the chain in IRS C.I., and then they have to get IRS Chief Chief Counsel Criminal Tax Attorneys involved, and so on and so forth.
So it’s a manual, costly process to prosecute tax crimes.
And given the IRS’s limited resources, they’re probably only looking at large-dollar-amount or high-profile cases with a high likelihood of conviction.
Like I said, I’ll probably do a deeper dive into IRS Criminal Investigation in another article, but if you just look at the 2021 IRS Criminal Investigation Annual Report, you can see that for fiscal year 2021, “only” 1,372 investigations were initiated for tax crimes, and of those investigations, only 850 resulted in a prosecution recommendation, and only 633 resulting in a conviction and sentencing.
So it’s not like there’s mass incarceration at the federal level for tax crimes.
I don’t say this to encourage non-compliance; like I said, there are certainly civil penalties and issues that arise from not filing your tax returns, but for the average person who gets behind on filing for a few years, you probably aren’t a big enough fish for the IRS Criminal Investigation Division to start an investigation on you.
Author:
Logan Allec, CPA, Founder and Owner
Logan Allec has been serving taxpayers as a CPA for over 14 years. After leaving his role at a "Big 4" firm, he started Choice Tax Relief to help everyday Americans who have found themselves behind on their taxes. He also educates thousands of people daily about tax relief on his YouTube channel. In addition to his CPA license, Logan also has a Master's Degree in Taxation from the University of Southern California (USC). He lives with his wife and children in the Los Angeles area. Learn more about Logan here.
