Understanding your risks
If you don't file your taxes, the IRS will file for you based on deduction assumptions. Thus, you might not get credit for everything you're entitled to get. The IRS then will send you a Notice of Deficiency CP3219N letter.
You have a full three months (90 days) to take action once you receive your notice. Failure to file either your return or a petition in Tax Court will trigger collections. From there, the IRS has the authority to levy wages or bank accounts. It also can put liens on properties. Liens show up on your credit report and may make it harder to get future loans with good interest rates. Refunds you'd otherwise get will go to what you owe, too.
The IRS calculates interest quarterly on any unpaid tax from the return's due date until the date you make a payment. The rate is the federal short-term interest rate plus 3% and interest compounds daily. If you file but don't pay, you'll be charged interest of 0.75% per month until you make a payment. The situation bleakens when you don't pay and don't file. You'll have interest plus a 5% per month "failure to file" penalty that can reach 25% of what's owed. If you file more than two months after the due date, the minimum penalty is either 100% of the unpaid tax or $135, whichever is smaller. Importantly, the IRS will give a first-time waiver on the penalty if you have a history of on-time payments. If you don't qualify for that waiver, request that the penalty be waived for probable cause.
The IRS usually prosecutes only for extremely high debts or clear instances of fraud.
What you can do
Your best bet if you can't pay your taxes right away often is to set up an installment plan by using the IRS's Online Payment Agreement Tool, or by filing the Installment Agreement Request Form 9465 and a financial statement Form 433-F with your return. Be aware, however, that you have to stay current on future taxes if you enter an installment. There's also a setup fee of $120 ($52 if you opt for automatic withdrawals). The IRS will waive that fee, however, if you think you can pay it in less than 180 days. A good strategy regardless of whether you get the fee waived is opting for the minimum required and paying extra when you can on your installment plan. This will reduce the risk that you fall behind and get more penalties.
You also can file for an extension using the Online Payment Agreement Application or by calling 800-829-1040. Extensions give you 60 to 120 days to pay in full.
Another option is to borrow to pay, thereby getting better interest rates. Borrowing from friends and family (provided you pay interest) and peer-to-peer lending sites are both permissible. If you pay with plastic, the company processing the payment will charge a convenience fee for a credit card and a flat fee for a debit card.
Lastly, you can file for an offer in compromise, which although rarely granted, lets you bargain down what you owe.
What you can do next
Even if you can't pay your taxes, make sure to file on time—then consider ways to pay what you can when you can.