What To Do If You Have Unfiled Tax Returns

Did you know that per statistics in the 2017 IRS Data Book, there were about 14 million delinquent taxpayers at the end of 2016 and 2017? That means that the IRS has identified 14 million people who should have filed tax returns but did not. With that said, falling behind on filing your taxes is something that happens to many people.

We know that this can be scary, and can cause one to have many questions about how to make it right with the IRS.  Luckily, there are steps that you can take to satisfy what the IRS will require of you and get you back into the system so you can get rid of the worry! So, here are 10 things you should know about the situation:

File even if you don’t think you owe. If you were employed with wages and had taxes withheld from your paycheck, it is possible that you may not owe the IRS at all.  This will depend on the amount withheld from your wages and any other deductions you may have (mortgage interest, etc.). If you have refunds, you should actually receive those for the last three years’ returns UNLESS you have amounts owed for other years. In that scenario, the refunds will be applied to any balances due for the other years.

File original returns to replace IRS created returns.  Sometimes, when you don’t file a return, the IRS files one for you.  In IRS terminology, this is called a Substitute for Return (SFR).  Our experience has been that a SFR is the worst tax return ever! It reports the income that shows up on W2s and 1099s but doesn’t give you any deductions or exemptions.  You may already have a bill from the IRS that was created in connection with a SFR.  The good news is that you can correct these returns, and possibly lower the associated tax and penalties, by filing an “original” return.

Gather your records.  When you have old tax returns to file, it is important for them to be as accurate as possible. So the first things you want to do is pull together your records for the years where you did not file.  This may include 1099s or W2’s you received for work your performed, mortgage interest you paid, or interest, dividends and stock sales.  Don’t worry if you are missing records because if you are:

Secure your IRS transcripts. Your records are supplemented by securing the IRS transcripts that will show what has been reported to the IRS. Basically, you want to make sure you report everything the IRS has for your SSN, otherwise, they will send you some notices claiming that you under reported income. Getting the transcripts will cross-check your records, filling in anything that is missing. The appropriate transcript to request is called the Wage and Income Transcript. You can get it via this page on the IRS website and you can request it online or you can use Form 4506-T to request it via mail.

Review the past six years of activity.    If you have six or more years of unfiled returns, make sure you do the above two steps for each year. Why? In most cases, the IRS requires the last six years’ tax returns to be filed as an indicator of being current and compliant.  This is per Policy Statement 5-133 and Internal Revenue Manual 4.12.1.3.  As such, make this your starting point of your analysis.

Review other sources of income. The IRS transcripts are a checking point, but you will also need to check for things that aren’t reported on them. For example, if there is income you earned that is not on the transcripts (e.g. cash payments), you need to make sure you calculate it and include it on your return.

Review your business income and expenses if you’re self employed.  Income can be recalculated using several methods, including 1099 reporting to the IRS or your bank deposits.  Working with this number, determining what you spent to generate that income. When done, take a look at what is left (i.e. the profit). You can then compare that number to what you spent for that year to live (e.g. rent, mortgage, utilities, etc.) to make sure it appears reasonable/logical. Too often, we see tax returns where there is no business profit, which then begs us to ask “so just how did you live that year?” Rest assured, if we can ask that question, the IRS WILL also be thinking of it too!

Perform a financial review if you think you may owe.  Unfiled returns are really a two-step process:

  1. Getting the returns prepared and filed and,
  2. Negotiating solutions for any balances due with the IRS collections division.  

To perform the second step, one has to prepare a financial analysis of their situation and present it to the IRS. This involves a review of your current income, living expenses, property and debts. It is often the case that the amount owed on unfiled returns cannot be repaid. So performing this analysis will help you determine if your “resolution” will ultimately be to enter into a payment plan, request an offer in compromise, or have your account be put in an uncollectible status.

Consider filing the returns separately if you’re married. If you’re married, but only one spouse was responsible for creating IRS debt, strong consideration should be given to filing a separate return. Filing separately can limit who the IRS can collect from – protecting the non-liable spouse.

File your returns in person if possible. If possible, the unfiled returns should be hand-filed at an IRS Taxpayer Assistance Center. Note that the centers are by appointment only so you will need to schedule it via the previous link. If you bring an extra copy to the center, you can get it stamped by the IRS as proof of filing.  If you are working with an IRS Revenue Officer, the returns should be filed directly with that person.  It can take the IRS several months to process the returns. But if you file them directly with their personnel, it can speed up the processing time, which will then “stop the clock” in terms of certain penalties.

If you owe money, the next step is to enter into one of the 10 resolution options solutions to solve your IRS tax debt as discussed on our sister site.

What Is An IRS Substitute For Return (SFR)?

Sometimes, when a person does not file a tax return on their own, the IRS will prepare one based on the information they have available.  This is called a substitute for a tax return or SFR. The IRS does this so they can assess tax and begin collection activities.  But just how does a SFR get filed and what are the ramifications?  Read on to find out.

Situations where the IRS will file a SFR
A SFR is typically filed when the IRS notices that a person hasn’t filed for a few years, but that person has income documents on file with them (e.g. W-2, 1099-MISC). The IRS will then file SFRs for all the unfiled years based on the information on those tax documents.

How does the IRS calculate the tax on a SFR?
The SFR is always prepared in the best interest of the government.  What this means is that they will use the filing status of Single and they will not include any deductions or credits.  Typically this can result in the taxpayer having a balance owed.  Now let’s think about that for a second.   If a tax return is prepared without any deductions, without any tax credits, it’s quite likely that the IRS’s calculation of tax is much higher than it should be.  Thus, in most cases, that’s just what happens. There are even instances that had the taxpayer filed the return themselves, the IRS would owe them a refund.

Does the IRS have the authority to file a return on your behalf?
The short answer is yes.  Congress authorizes the IRS to prepare tax returns based on information available to it in situations where a person has not filed a return (Internal Revenue Code 6020).

What happens after the SFR is filed?
The IRS will send you a Notice of Deficiency CP3219N (90-day letter) proposing a tax assessment.  You then will have 90 days to file your past due tax return or file a petition in Tax Court.  If you do neither, the IRS will proceed with their proposed assessment.

Technical implications of having a SFR filed on your behalf
It’s important to know that a SFR is not an “original” return (i.e. filed by the taxpayer).  As such, the IRS treats them differently when it comes to several things.  A SFR that is not signed by the taxpayer:

  • Does not start the collections statute of limitations
  • Does not start the audit statute of limitations
  • Has no effect on the refund statute of limitations

Per the Internal Revenue Manual 25.6.1.9.4.5, “the assessment date will start the period for the statute of limitations for collection per IRC Section 6502(a)(1), but does not start the period of limitations for assessment.”  However, if a person agrees with the SFR, then signing it does start the audit statute of limitations.  From the same section of the Internal Revenue Manual, “If the taxpayer signs a SFR return prepared from income information received from the taxpayer, it becomes the taxpayer’s return per IRC Section 6020(a) and starts the assessment period of limitations.”

Should a person file an original return after the IRS files a SFR?
If a taxpayer didn’t file an original return, they always have the opportunity to do so.  Filing the original return after an SFR has been filed allows the taxpayer to possibly choose a more advantageous filing status if applicable (e.g. Head of Household, Married Filing Jointly, etc.) as well as include any deductions and credits they are entitled to.  This may reduce or eliminate the tax that the IRS says the taxpayer owes.

The IRS has temporarily suspended the ASFR case selection
In September of 2018, a Treasury Inspector General for Tax Administration (TIGTA) official  announced suspension of the automated substitute for return (ASFR) program.  As such, selection of new cases (i.e. the IRS filing SFRs on a taxpayers behalf) is not occurring at the moment.  This is due to “resource limitations” which can be construed as the series of IRS budget reductions that have taken place in recent years.  Furthermore, the IRS has stated that they remain committed to taking many actions in 2018 to improve methods of allocating nonfiler cases across their potential compliance treatment streams, and this includes the ASFR program.

So while the IRS is not “currently” filing SFR returns for taxpayers, don’t expect it to last forever.  It’s also important to note that the IRS said it is continuing to work on active ASFR cases and ASFR reconsiderations.