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Understanding the Substitute for Return: When the IRS Files a Tax Return for You

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Each year hundreds of thousands of taxpayers forgo filing their federal income tax returns. If you are a nonflier or have wondered what the risk may be for opting out of your annual filing requirement, you might be surprised to learn that in these situations the IRS can file a tax return for you, assess tax against you, and then pursue collection of the tax including interest and penalties.

This article explores the basis for an IRS Substitute for Return, the process that it involves, and how taxpayers can best respond to minimize their tax liability.

What is a Substitute for Return?

Pursuant to Internal Revenue Code section 6020(b), the IRS has the authority to file tax returns for delinquent taxpayers as part of its Substitute for Return (“SFR”) program. The SFR is generated based on third-party information provided to the IRS by employers, banks, and other payors which includes W-2 and 1099 information contained in your Wage and Income transcripts.

The SFR will not include any tax credits or deductions you may otherwise be entitled to.  For example, if you are a self-employed person with 1099 income, your SFR would not include any of the business deductions (travel, meals, entertainment, home office, etc.) that you would normally deduct from your business income.

In addition, the SFR will only use a single or married filing separate status and calculate tax based on the standard deduction. For example, if you are married and typically itemize your deductions, the SFR will not take your married filing jointly filing status or itemized deductions into account.

For the forgoing reasons, the SFR tax liability will invariably be much higher than if you were to file the tax return yourself claiming the appropriate credits deductions, exemptions, and filing status.

What is the Substitute for Return Process?

Typically, one year after a taxpayer has failed to file his or her tax return, the IRS will send a CP2566 Notice which advises that the tax return has not been received and provides a proposed tax assessment which is based on income information provided by third parties. The assessment will include interest and penalties as well.

In response to Notice CP2566 the taxpayer has 30 days to sign and return the consent to assessment, file a 1040 Individual Income Tax Return, or provide a statement explaining why the taxpayer believes he or she is not required to file.

If the taxpayer does not respond within the proscribed 30-day time period, the IRS will then send a Notice of Deficiency also known as a CP3219 Notice or a 90-day letter, which reiterates the proposed tax assessment with interest and penalties and advises the taxpayer of the right to appeal to U.S. Tax Court.

The taxpayer will have 90 days to sign and return the consent to assessment, file a completed Form 1040 Individual Income Tax Return, or provide a written explanation as to why there is no filing requirement.

If the taxpayer fails to respond to the Notice of Deficiency within 90 days, the proposed assessment becomes an enforceable tax liability and the IRS may pursue collection of same via the filing of a tax lien or tax levy (e.g., wage garnishment or bank levy), subject to applicable notice requirements.

How to Respond to a Substitute for Return?

As soon as the IRS indicates that it intends to file an SFR, it is advisable to prepare and file your own return to reflect the correct filing status and the correct number of dependents and claim any applicable deductions or tax credits.  The IRS will generally adjust the taxpayer’s account to reflect the correct figures.  This will likely have the effect of reducing the overall tax liability including a reduction of interest and penalties that were part of the SFR assessment.

If the SFR assessment has already occurred (i.e., taxpayer did not respond to the Notice of Deficiency within 90 days), the IRS will review any subsequently filed original return as part of an Audit Reconsideration.  This review process takes a longer period of time and occurs under a higher level of scrutiny.

Beyond reducing the overall tax liability, additional reasons to file your original tax returns include the following:

  • You only have 3 years from the original filing deadline to 1) claim a refund for withholding or estimated taxes that you might have paid in or 2) enjoy the benefit of certain tax credits.
  • Unfiled tax returns can potentially lead to criminal prosecution for tax evasion.
  • You can’t avail yourself of other relief such as bankruptcy or settlement with the IRS, or get a tax lien or tax levy removed, until and unless you are filing compliant.
Do You Need a Tax Attorney?

A tax attorney can access your IRS Account Transcripts and your Wage and Income Transcripts to advise you as to whether a Substitute for Return has been assessed and what income information was reported by third parties to the IRS on your behalf.  These transcripts are excellent resources to aid I the preparation of the tax return and thus sufficiently respond to an SFR assessment.

If the IRS does not accept your original tax return via the Audit Reconsideration process, a skilled tax attorney can help you challenge the assessment in other ways including via statutory remedy and appeal.

The experienced tax attorneys at Segal, Cohen & Landis have successfully helped clients challenge substitute for return assessments and reduced overall tax liabilities through the following services:

  • Filing a refund claim after satisfaction of the SFR assessment
  • Application for Offer in Compromise Doubt as to Liability
  • Request a Hearing through the Collection Appeals Program
  • Application for Offer in Compromise Doubt as to Collection
  • Establishment of an Installment Agreement or Not Collectible Status

If you are interested in having a complimentary consultation with one of our partner attorneys regarding your tax matter, please feel free to contact us at 866-505-1872. We would be happy to advise you as to how we can resolve your case and how much it would cost.

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