The Substitute for Return- When the IRS Is Tired of Waiting for You to File
The IRS can collect tax that may be owed only after an assessment is made. That assessment of tax can be based on one of two events: 1) the taxpayer can voluntarily file his return as required or 2) the IRS can issue a Substitute for Return (SFR) based on information that has been reported to it by third-parties. When information has been reported to the IRS that indicates that a substantial balance is likely due and the taxpayer fails to respond to multiple IRS inquiries regarding the unfiled return, an SFR may be issued by the IRS, allowing the collections process to begin.
What is a Substitute for Return (SFR)?
An SFR is very similar to a tax return that you would file yourself, but it is based only upon the information that the IRS is privy to from third-party reporting. This means that the SFR is not going to factor in many items that may be deductible to you, especially if you are self-employed, given that the IRS does not know about your business expenses (because they are not reported to the IRS by third parties). The IRS is also not going to consider whether you have any dependents, a recently-deceased spouse that could allow you to qualify for special filing status, whether you may qualify for head of household, or whether married filing jointly would have provided you with an optimal filing status. Thus, in most cases, SFR’s do not work out to the taxpayer’s benefit.
What Are Your Options When You Receive a Substitute for Return?
Because an SFR is an assessment of tax, if you receive an SFR you have the option of accepting the IRS’s figures and proceeding as you would in most any other collections matter; such as paying the tax in full, entering into an installment agreement, filing an offer in compromise, or obtaining currently not collectible status based upon your financial circumstances. Unfortunately, one important option that will not be available to resolve your tax debt in a situation where an SFR is issued is discharging your tax debt in bankruptcy.
But there is another option—you do not have to accept the IRS’s figures presented on the SFR. You may choose to file your own return, based on all the information known to you and reflecting your most advantageous filing status, including all of your allowable deductions, dependents, credits, and of course all of your reportable income. Your validly filed return will replace the SFR issued by the IRS and your collections matter will proceed based on those usually more advantageous figures. However, important to note is your potentially increased risk for audit in this scenario. Returns that are filed late are at a higher risk of audit anyway, due to the fact that they are more likely to be filed based on estimates or unreliable records. But in the case where an SFR has been issued and the taxpayer then files a return replacing that SFR, there is even more of an incentive for taxpayers to estimate or use unreliable records that they could not support in an audit (because there is a known amount of tax, penalties, and interest that they are trying to avoid). Thus, when submitting a return in this situation, it is a good idea to have evidentiary support that could withstand IRS scrutiny in case an IRS examination ensues. In cases where the dollar amount of the change between the SFR and subsequently filed return is significant, there is a good chance that an IRS audit will ensue.
What Options Are Available to Non-Filers?
If you have received a letter from the IRS notifying you that they have not received a return that their records indicate that you should have filed, the best thing to do is consult your tax professional right away, provide her with the notice you received, and provide all the tax records that you have available for that tax period. It is possible that you may not be required to file, such as in a situation where you have business expenses that exceed business income. However, your tax professional may determine that it is best you file a return anyway, to present this information to the IRS that you are not required to file and to also get the statute of limitations running. If you have received one of these notices, though it is your right to self-prepare your return, it is probably best to have a tax professional’s due diligence involved to potentially head off any IRS inquiry, or to ensure that you have the necessary backup to survive an IRS examination.
What Happens If You Cannot Pay What is Owed?
Even if you cannot pay what is owed in an SFR situation, in a scenario in which you have filed your return, or where you are putting off filing because you are afraid of what you might owe, there are tax debt resolution options that are available to you. The best of these options are available to taxpayers that are in compliance or can get into compliance as soon as possible. Compliance includes filing the six most recent tax returns and paying all withholding tax and/or estimated tax payments that are due for the current tax period. Filing timely returns can allow for a potential discharge of the tax debt in bankruptcy down the road, so even if you cannot pay the tax, it is very important to file on time, if you are required to file a return for the tax period in question.
If you have received a notice from the IRS inquiring as to an unfiled return, if a Substitute for Return has been issued, or if you are aware that you have past due unfiled tax returns, do not stress! Simply contact me using the form below and I would be happy to discuss your options with you.