Many clients that come into our office have not filed tax returns for an extended period of time. These clients want to get back into compliance and get their lives back on track. The most common reason for not filing tax returns is – I couldn’t pay the balance due, so I didn’t file. It is much better to file the return and not pay, then to not file at all. As listed below, significant penalties accrue rapidly when tax returns are not filed timely.
Thankfully, preparing past due tax returns is not an insurmountable task. Additionally, there are several factors that may work in your favor. As a general rule, so long as the IRS has not filed returns for you, you will not be required to file tax returns that are more than 6 years past due. The IRS has recognized that it is extremely difficult to obtain records dating back for such a long period of time and has implemented an administrative policy that does not require these returns to be filed.
For the years that tax returns are required to be filed, wage and income transcripts can be obtained directly from the IRS. These transcripts show all of the income that was reported to the IRS under your social security number, and will include 1099’s, W-2’s, interest income, stock transactions, and other relevant documents. Additionally, if records are not available, deductions, expenses, and credits can reconstructed to reduce the amount due.
Substitute For Returns (SFRs)
If the IRS and state do not receive a tax return for you their most likely response will be to file one for you. For the IRS this process is called filing a Substitute For Return or a 6020(b) return.
The IRS has a lot of information reported to them by your employer, your bank, and your customers. They will use this information to determine your gross income and file a return for you. Since they are not aware of your filing status or any business or personal deductions you can take they will not give you credit for any of these items.
This will usually result in a return with a balance due substantially higher than what you actually owe. Whatever number the IRS determines will generally be shared with the State that you resided in, and the State will then prepare a return for you as well, making matters much worse.
Similar processes are used for business returns including wage withholding and sales tax, although the government typically has less information available to them. In the case of payroll taxes, the IRS and States will typically use past tax returns that you filed, records of W-2’s that you filed, or unemployment information you reported to reconstruct a tax return.
In most cases you can request that the IRS reconsider their assessments by providing a copy of the tax return with the figures that you believe are accurate. These returns should be accompanied with a detailed explanation, and should be submitted to a particular unit within the IRS. The IRS has detailed administrative guidance on whether to accept or reject these returns.
The Consequences for Not Filing Tax Returns
Criminal penalties for willful failure to timely file tax returns 26 U.S.C. § 7203:
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 income tax return, keep any records, or supply any information, who willfully fails to pay such estimated tax or tax, make such income tax 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.
If a taxpayer seeks to correct the problem before an IRS investigation or examination, it may be feasible to use the IRS’s “voluntary disclosure” policy to file missing returns and avoid prosecution. In connection with the voluntary disclosure program, the taxpayer must file accurate and truthful tax returns. This policy applies to taxpayers who:
- Voluntarily inform the IRS of their failure to file for one or more year
- Had income from only legal sources
- Makes the disclosure prior to being informed that they are under criminal investigation
- Files a correct tax return or cooperates with the IRS in ascertaining their correct tax liability
Failure to File Penalty and Interest
If you don’t file by the due date of the tax return, you may have to pay a failure to file penalty. The penalty is 5% of the tax not paid by the due date for each month or part of a month that the return is late. The maximum penalty is 25% of your tax, but it is reduced by the failure to pay penalty (1/2 % per month for 50 months) for any month in which both penalties apply. You will not be liable for the penalty if you can show “reasonable cause” for not filing on time. See the IRS Penalty Relief Tab.
If you fail to file a tax return, the IRS will be extremely difficult to deal with and may institute enforcement action including bank levies, wage garnishments, and filing a Notice of Federal Tax Lien. The IRS will generally not enter into any payment agreement or enter into tax settlement until you are Compliant and have filed all delinquent tax returns.
Also certain federal benefits, like Social Security and Medicare, are available only if you file federal tax returns. Because benefits from these two programs are based on the income you earn during your life, the agencies depend on information in your tax returns to calculate your benefits. Some state benefits like unemployment compensation are also based on income reported on your tax returns.
Statute of Limitations
To claim any tax refunds due, all tax returns must be filed to claim the refund within the three years, the money becomes the property of the U.S. Treasury. After the statute has run, not only does the IRS keep the refund check, but they generally will not apply any credits to other tax years.
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