Sometimes taxpayers fail to file income tax returns for a number of years. There are numerous reasons why taxpayers fail to file their tax returns. In many instances it is because the taxpayer does not have the money to pay their liability and the problem snowballs out of control. However, the IRS can still seek to collect tax from you and it can cause major problems.
Even if you do not timely file your federal income tax returns, the IRS can still prepare returns for you from the IRS’s “own knowledge and from such information as he can obtain through testimony or otherwise.” Generally, this means that the IRS will prepare a “substitute for return” (“SFR”) based upon items that have been reported to the IRS from third parties (e.g., W-2, Form 1099-Rs’, Form 1099-C’s, etc). The IRS prepares SFRs so that there is an “assessment” on the government’s books. This allows the IRS to begin collection actions, such as begin the statutory notice cycle, file liens, impose levies, revoke passports, etc. In order to enter into a collection alternative (i.e., currently not collectible status, installment agreement, or offer in compromise) to deal with your balance, you generally have to be in current compliance. Furthermore, failing to file returns puts taxpayers at risk for criminal prosecution and can lead to additional penalties.
Preparing old tax returns can be challenging and time consuming, but it is not an impossible task. Dealing with unfiled returns before the IRS comes to you, generally reduces the risk of criminal prosecution. Confronting unfiled tax returns is daunting, but with the help of an experienced tax professional, you can obtain piece of mind and some certainty regarding your debt to the IRS.
Since the IRS statute of limitations on assessment does not start until a tax return is file, tax years with unfiled returns are open to IRS scrutiny indefinitely.
How far back should you file?
Generally, most taxpayers can follow the IRS’s policy and file the last six years of tax returns. See IRS Policy Statement 5-133 (link) and Internal Revenue Manual 4.12.1.3.
What happens if your records are incomplete?
While it is important to gather as much information as possible in your possession, in many cases, a large amount of the information needed can be retrieved through IRS Wage & Income transcripts. Each year, the IRS receives information from third parties (e.g., W-2, Form 1099-B, Form 1099-Rs’, Form 1099-C’s, etc), which are linked to you social security number. A taxpayer or the taxpayer’s representative can obtain the information that the IRS has on file, so that the taxpayer can file an accurate tax return.
The process is somewhat more difficult for taxpayers that own and operate businesses. However, it is usually possible to reconstruct financial results from bank statements and bank records.
What happens if you cannot full pay the liability?
Once the returns are filed, you can seek collection alternatives if you cannot full pay the tax, interest, and penalties. Alternatives include seeking currently not collectible status, entering into an installment agreement, or submitting an offer compromise.
What Happens If the IRS Already Prepared SFRs?
Even if the IRS has prepared substitute for returns (SFRs), it can still be advantageous to prepare unfiled tax returns. The IRS will generally utilize what information it has at its disposal, but it will not go out of its way to help you. For example, sometimes the IRS will receive information regarding gross proceeds form the sale of stock or assets, but it does not receive information regarding your tax basis in the item(s) sold. In that case, the IRS will assume that your gain equals the gross proceeds and not give you any credit for basis. If you have proof of your basis, then you can file a return to reduce the balance that the IRS arrived at by filing a SFR.
Overview of Typical Unfiled Returns Engagement
If you received an IRS levy notice I can meet with you to review your case and provide some preliminary advice on steps to take. And after an initial free consultation, you can decide if you want to retain me to help you challenge the IRS levy. Below is a brief summary of the initial steps in a typical IRS Levy engagement.
Initiate Engagement and Set Path Forward
During the initial meeting, we can discuss your filing history and agree on a general approach to solving your tax issues. Generally, but not always, we will seek to file the past six years of tax returns to match IRS Policy Statement 5-133.
Assemble and Review Documentation
After signing an engagement letter and power of attorney, you can provide as much documentation as you have in your possession regarding the tax years that we determine is necessary to file. I can then pull wage and income transcripts to use in the preparation of back returns.
Draft Tax Returns & Plan to Deal with Tax Obligation
After reviewing your records and transcripts, I can prepare draft returns for your review. At this point in time, we can also begin to discuss alternatives for dealing with your likely balance. Usually, I will ask for you to fill out a Form 433 – Collection Information Statement for Wage Earners and Self-Employed Individuals, so that we can determine how the IRS will view your collection potential. This will give us a sense on what options you have to satisfy your liability.
Finalize and Submit Returns
After clearing any comments and tracking down any additional pieces of information, finalized returns will be signed and submitted to the IRS. After the returns are submitted, it will take some time before the tax returns are processed and the assessments become final.
Work with IRS to Satisfy Debt
After the assessments become final, I will work with the IRS automated collection system or an IRS Revenue Officer (if your debt is very large, ~$250,000+) to enter into a collection alternative. If you do not work with the IRS, then the IRS will eventually start to take aggressive action, including levy your assets in order to offset the liability.
Related Issues
State Unfiled Tax Returns
If you have unfiled state tax returns, I can prepare necessary state tax returns. Generally, the IRS will share information regarding your income with your home state, so it is usually a good idea to file state tax returns at the same time that you file late federal income tax returns.
Foreign Bank Account & Financial Interest Reporting
If you have foreign bank accounts or financial assets, then we will need to determine if a voluntary disclosure is necessary or if it would be prudent to use some other type of procedures (i.e., delinquent FBAR submissions, Streamlined Filing Compliance Procedures (SFCP), etc.) See here for more on voluntary disclosures.
Unfiled Employment Tax Returns
If you own and operate a business, it is also important to ensure that you have filed all necessary employment tax returns. Even if you own a business through a corporation or limited liability company, you may still be at-risk of personal liability. It is best to proactively determine if you owe any additional tax.