When Failure To File Your Tax Returns Go Really Bad: IRS Substitute For Returns
March 3, 2016
In the world of tax practice, variations of the following scenario are the most common reason why individuals or businesses end up owing the IRS more money than they can pay:
John and Jane open a business. They spend all their hard work and effort establishing a business, building a client base, pumping money into the business and getting vendors. All their hard work pays off, and after 2 years their business is running well and at a profit.
However, John and Jane realize that they were not filing tax returns during the past 2 years. Scared of the consequences of what will happen if they come clean and file now, they decide to ignore the situation and carry on with business as usual. After all, the IRS would have contacted them by now if they were going to get caught.
Taxpayers fail to consider that the IRS is a sleeping giant. If you do not file your tax returns, it can take years for the IRS to catch on and take action, even more so if no informational forms such as 1099’s or W2’s were issued to you. However, when you do not file your tax return, the IRS is usually not in a hurry to start collecting your tax liability, since the statute of limitations on collecting or auditing your tax liability does not start to run until you actually file your tax return. Also, the IRS uses the failure to file penalty, failure to pay penalty and their exorbitant interest charges to make you really pay for not filing your tax returns. What should have been a $25,000 tax liability if you filed timely could easily escalate to a $60,000 tax bill if you file 5 years late. That’s a much better rate of return for the government than most of the investments they make.
5 years have gone by and John and Jane have still not filed their tax returns. Suddenly, they receive a friendly letter from the IRS, reminding them that they have not filed their tax returns for the past 5 years. John and Jane are very disconcerted about the letter, yet they choose to do nothing, since that has worked well in the past. The next notice they receive is not so friendly. It states if they do not file tax returns, the IRS will file one for them, called a Substitute for Return.
When the IRS files a Substitute for Return, they do not take into account any deductions or exemptions the taxpayers may have. For John and Jane, they will not take into account any rent they paid, supplies they purchased, or any of the workers they paid.
The next letter John and Jane receives is an IRS Notice of Deficiency, showing a tax liability for 5 years, including penalties and interest of $300,000. Once that balanced becomes assessed, the IRS can collect on this balance by levying their bank accounts and other assets, and placing a lien or even seizing their home. They could also face criminal charges.
The best thing to do if you have not filed your tax returns is to be proactive. Dealing with your tax problem may seem like a stressful and daunting task, but filing your own tax returns give you the control to take your expenses into account, and to keep penalties and interest to a minimum. Once you have filed your tax returns, the IRS will also be willing to setup an installment agreement with you, or even settle your tax liability for less than you owe through their offer in compromise program. This option is not available if you did not file your tax returns and the IRS filed a Substitute for Return for you.