We've all heard stories about people who have not filed their taxes. Imagine what you could save if you simply didn't pay any tax? If this seems like a fairy tale to you, rest assured. It is. While some people may get away with it for a while, cheating the IRS won't work. Sooner or later, good ol' Uncle Sam will catch up with people who don't file. Just ask the public accountant in Michigan who didn't file for four years - he spent five months in prison, five months on house arrest and $190 thousand dollars in back taxes, penalties and interest.

Don't pay or don't file, that's the question

There are separate penalties created by the IRS for both of these situations. Some people think that if they can't pay their tax bill, they simply won't file. It's a big mistake not to pay and an even bigger one not to file, regardless of the actual cost of your bill. Here's why:

The amount you owe is penalized at 5% per month of non-payment. The amount you owe is penalized at a whopping 47.5% when you fail to file - 22.5% for late filing, 25% of the total for late payment. And don't forget interest, which is compounded daily until the tax is paid off.

Regardless of whether or not you can afford to pay the tax, the point is you should always file.

What happens if you don't?

The IRS may notice that you didn't send them any mail on April 15th. In some cases, they will file something called a "substitute return" for you. But remember, the IRS is not looking to save you money and lower what you owe. A substitute return only allows you to claim one exemption and doesn't take any of your own deductions into account, so you will end up with a higher tax liability than if you had simply filed your own return.

Other benefits of filing a return include:

• Beginning the statute of limitations on allowed audits (three calendar years in most instances). The IRS has only three years from the date you file in which they can audit your return - but you need to file to take advantage of that limit.
• Beginning the statute of limitations for collection of tax, penalties and interest (ten years after assessment) on your return. This means the IRS cannot collect the tax, interest or penalties after ten years from the date you file. However, if you don't file, the ten year expiration clock won't start ticking, and the IRS can collect for years and years.
• Starting the clock to allow your full tax bill (including interest, and penalties) to be forgiven by Chapter 7 Bankruptcy (two to four years after filing).

If the IRS audits you and determines you owe it money, you will receive a Notice of Tax Due and Demand for Payment letter. This bill will outline exactly what you owe, including applicable interest and penalties. Interest and penalties continue to accrue, so you are encouraged to settle your bill as quickly as you can. The IRS accepts credit cards, electronic transfers, check, cash or money orders.

What if I can't cover my bill?

The smartest thing to do, always, is to pay the maximum that you can, reducing the amount of interest and penalties you'll owe. As soon as you realize you'll have to be short on your payment, immediately call, write or visit the nearest IRS office to explain your situation. Based on your situation, the IRS may offer one of the following payment arrangements:

• Installment Agreement

You may be able to divide your bill into smaller, more manageable monthly payments by establishing an installment agreement.

• Temporary Delay

The IRS may allow you to postpone the payment of your tax debt if you can prove to them that you cannot pay it off. But keep in mind, this delay is only temporary. The IRS will closely monitor your ability to pay and may also file a Notice of Federal Tax Lien on your assets to guarantee the government's interest in your assets.

• Offer in Compromise

An Offer in Compromise is your final option to settle your tax bill, available only if none of the other collection methods work. If you qualify for an Offer in Compromise, the IRS will bring your balance down to zero in exchange for the offer you make, typically less than the balance due. An Offer in Compromise will take care of all outstanding taxes, interest and penalties. Please note that a $150 fee is charged for filing Form 656, Offer in Compromise.

What if you receive a bill from the IRS but you notice errors? Write or call the IRS office which sent you the bill as soon as possible or better yet, visit your local IRS office in person. Keep a copy of your bill and make sure to bring along any evidence that will help the IRS see why you are sure they made a mistake on your bill.

If you are left with any information from this article, remember this: taxpayers should always file a tax return, even if they can't pay the bill. If you don't file a return and ignore the IRS demands for payment, you stand to face all kinds of enforcement action, including penalties and going to court. File and pay your taxes and avoid a lifelong, expensive relationship with your friends at the IRS. For more information, visit the IRS Web site at www.irs.gov.

LegalZoom is not a lawfirm and can only provide self-help services at your specific direction. Information contained above is subject to change and is not applicable to every state. Visit LegalZoom.com for specific state-by state-documents.

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