Failing to file your taxes can result in the IRS filing a Substitute for Return for you.
When the IRS completes a return for you, this type of return is called a Substitute For Return (SFR) - the IRS is given the authority to prepare this type of return under IRC § 6020(b).
The IRS will use information that it has received from your employer (W-2 forms), from your banks (Form 1099-INT), your investment brokerages (Form 1099-DIV), people you have done work for (Form 1099-MISC), rents or royalties you have received (Form 1099-MISC), funds you have received from partnerships (Form K-1), and any and all other sources of income that has been reported to the IRS to come up with your taxable income on the SFR.
Now, some people may say “Hey, that’s great, if I don’t file my taxes the IRS will take care of it for me”. However, nothing about a Substitute for Return is great and when one is filed on your behalf, it usually brings very bad side effects.
The first problem is that you will have automatically been assessed the Failure to File and Failure to Pay penalties. The Failure to File penalty adds up quickly - the amount is equal to 5% of your tax liability per month (up to a maximum of 25%). The Failure to Pay penalty is less than the Failure to File penalty but also will add to your tax debt at the rate of 0.5% per month (again capping out at 25% of the tax owed). In addition to the penalties, the IRS will also be charging you interest on what you owe. As you can imagine, once the ball starts rolling, the penalties and interest can very quickly become a large number!
The other thing you have to ask yourself, when the IRS files an SFR for you is:
Do you really think the IRS is going to be trying to find all the deductions and credits I am entitled to?
The answer is obviously, no. The IRS will not apply all of the exemptions, credits, or deductions that may be in your favor when they are preparing your SFR. In fact, the Internal Revenue Code only allows the IRS to apply the standard deduction and one exemption. Without having all of the credits, deductions, and exemptions you are entitled to, your tax liability can be overstated and is often grossly overstated.
The other thing that the IRS does when it prepares a Substitute for Return is that is will automatically file the return as either Single or Married Filing Separately. If you are married, filing with the status of Married Filing Jointly is typically more in your favor, so this automatic election that the IRS makes will mean your return will generally be subject to many marriage penalties. If you can file as Head of Household this preferential filing status would also not apply for a Substitute for Return.
The IRS assesses a lot of tax, interest, and penalties under the Automated Substitute for Return program. The latest numbers show that in the fiscal year 2018, the IRS assessed $685,731,000 via Substitute for Returns*. Believe it or not, the Automated Substitute for Return system has actually been turned off for about four years and was just turned back on in May 2019. With the system back on, and with the IRS being granted additional enforcement funds in 2020, we anticipate that this number will jump significantly in the years ahead. There should be more and more taxpayers who face Substitute for Returns in the years ahead!
Once an SFR has been completed, the IRS will ask taxpayers to consent to the proposed tax, but if the taxpayer does not respond as so many taxpayers do when facing tax problems, the IRS will issue a statutory notice of deficiency and assess the tax, penalties, and interest and will begin the collection process. The collection process can include:
Filing a Notice of Federal Tax Lien
Issuing a Levy on your bank accounts
Garnishing your wages
And even, seizing your property.
The good news is that we can file an original return under audit reconsideration (the mechanism the IRS uses to contest an SFR) that, if accepted, by the IRS will replace the Substitute Return. Many taxpayers who have SFRs filed by the IRS will have very large tax liabilities and often by simply filing an original return, we have found that that that tax liability can be reduced significantly or possibly even result in a refund - especially if we also seek tax resolution strategies such as penalty abatement.
Because the tax law is so complicated and taxpayers are often overwhelmed when they are in the trows of tax problems, they often don’t even know that they have had an SFR filed by the IRS. If you owe back taxes and retain is to assist you, the first thing that we do at Resolution Tax Services is to obtain your entire tax history from the IRS and fully analyze the reports. We will be able to determine if the IRS did submit SFRs for your and if so, we will work with you to decide if filing original returns will possibly reduce your tax liability.
If you owe back taxes and are ready to seek a permanent solution to your tax issues, call us today at 833-StopIRS to schedule a Free No-Obligation consultation. We look forward to discussing how to get you back on track!
*Source: IRS Data Book, 2018