IRS Substitute Returns
Definition and Process
Investigation of Non-filers
Delinquent tax returns can be identified and worked by the IRS Examination Division, Collection Division, or the Service Center. Once a nonfiling situation has been identified, the Internal Revenue Manual (IRM) tells the assigned agent to review the situation for fraud. If there appear to be indications of fraud, the agent is instructed not to solicit returns or payment, but to refer the case to the Criminal Investigation Division. Assuming no indications of fraud, the IRS agent will contact the nonfiler and demand that he/she file all delinquent returns using Letter CP-515 and CP-518.
If after proper notice the taxpayer fails to file the requested return(s), the matter will be referred to Automated Substitute for Return (ASFR) or the Examination Division for preparation of a return by the IRS under the authority of IRC §6020(b). There is no precise timeline; sometimes the IRS moves slowly and does not get around to filing the SFR until several months, or even years, after the return is due. Once a case has been referred to ASFR, the ASFR system generates a thirty-day letter to the taxpayer requesting that the taxpayer file a return. If the taxpayer files the return, or provides proof that a return was not required, the case is closed in ASFR. But if no response is received, the system sends a ninety-day letter and the IRS-generated SFR. Eventually if the taxpayer does not respond, the tax liability is assessed, the case is closed in ASFR, and is passed on to the Collections Department of the IRS where liens and levies are likely to ensue to forcefully collect the past due taxes.
Impact on Balances, Refunds, Resolution of Case
If the IRS files a SFR, it is done based only on the information available in IRS
computers that has been obtained from various corporate and private industry sources. This typically results in a tax liability that is greater than if the taxpayer had filed his/her own “original” return or if the taxpayer files after a SFR is filed (a.k.a. SFR “reconsideration return”). The tax liability on a SFR is artificially inflated because the IRS does not include any additional exemptions or expenses that the taxpayer may otherwise be able to claim. The IRS includes as income the gross proceeds of a sale (not the gain after reduction for basis), and the IRS uses the standard deduction rather than itemizing deductions. Furthermore, the filing status used for SFR returns is typically single even if there are dependants, or it is married filing separate even if the filing status really should be married filing joint.
The Internal Revenue Code limits the time within which a taxpayer may obtain a refund of overpaid taxes. In general, a taxpayer must claim a refund within three years from the time the tax return was filed, or two years from the time the tax was paid, whichever period expires later. Withheld taxes and Estimated Tax Payments are deemed paid on April 15th of the year following the tax year in question. However, if no return is filed, a refund claim must be filed within two years of the date the tax was paid.
Non-filer cases typically take longer to resolve. And once a SFR is filed, the delays can be multiplied because processing of SFR reconsideration returns is not the highest priority at the IRS. According to the IRS, past due tax returns take approximately 6 weeks to process, if accurately completed. However, a past due reconsideration return can take several months to process because current-year tax returns normally get priority. Besides having to deal with an overstated IRS return and the delays described above, the IRS will take additional enforcement steps for those who repeatedly fail to file year after year.
Normally all past due tax returns must be filed before the IRS will consider resolving a past due tax account by way of an Installment Agreement, Currently Not Collectible status, or Offer in Compromise. However, as long as a SFR has been generated, failure to file an original return or a reconsideration return does not necessarily prevent resolution of a taxpayers delinquent tax account. The Internal Revenue Service is usually willing to move forward if the taxpayer has no interest in filing a reconsideration return or cannot reconstruct the IRS tax information necessary to file it.