When you don’t file a U.S. Individual Income Tax Return (Form 1040) there are several actions that the Internal Revenue Service (IRS) will take in the assessment and collection of federal income taxes. These actions generally begin with sending you a “friendly” letter requesting your tax return to a series of more intimidating letters ultimately demanding you file your tax returns and threats of levies, garnishments, seizures and other more serious collection actions.
When you do not reply to the IRS letters or IRS notices sent and not file your tax returns; eventually the IRS will prepare a tax return for you, assess any taxes you may owe and ultimately proceed with collection actions to obtain any monies that you may owe. The preparation of your tax return by the IRS is also known as a Substitute for Return or SFR.
The Problem with the Substitute for Return
The Substitute for Return is based on extremely limited information, that has been provide by others to the IRS such as wages you were paid, amounts you received from self-employment, securities sales and other income you have received.
In preparing a Substitute for Return, the IRS will prepare the return without the adequate consideration of your filing status, exemptions, dependents, income adjustments, deductions and other tax credits that may apply. The problem with the Substitute for Return is that the taxes assessed by the IRS are almost always greater that the taxes you may really owe.
The Good News and the Bad News for Non-Filers
The bad news is that if you never filed your return and the IRS assessed taxes based on a Substitute for Return, you are legally liable for the taxes that were calculated, whether they’re right or wrong, and sooner or later the IRS will catch up with you for the payment of these taxes.
Don’t pay your taxes and the IRS has 10 years to collect them from you. On the other hand, if you are entitled to a refund, you only have 3 years to collect your refund. Don’t file your tax returns and you will lose your right to any refunds you may have been entitled to.
The good news is that even if the IRS filed a Substitute for Return and assessed taxes more than you should be liable for, you can generally file your tax returns late and remain liable only for what you owe.
Even if you can’t pay your taxes, filing your tax return now limits the amount of time in which the IRS can collect. Generally, the IRS has 10 years to collect taxes that you may owe. Although 10 years is a long time, if you filed your late tax returns years ago, that 10 year collection period may have already expired, or would be about to expire by now. Don’t file your tax returns ever and the collection period extends indefinitely.
Common Reasons Why The IRS Assesses Higher Taxes Than You May Owe
Filing status – Your filing status is used to determine your filing requirements, standard deduction, eligibility for certain credits, and your correct tax. There are five different filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household and Qualifying Widow(er) with Dependent Child. In preparing the Substitute for Return, the IRS will apply a filing status that will result in the greatest amount of income tax.
Dependents and exemptions – Your taxable income will generally be reduced by almost $4,000 for each exemption you claim. In preparing the Substitute for Return, only a single exemption will be applied.
Capital gains – Perhaps the most common reason for the overstatement of taxes that may be owed is the failure to accurately calculate gains on security sales. In preparing the Substitute for Return, taxes are based on the selling price of securities with no consideration given for what you paid for the stocks, bonds and other intangible assets you sold.
Self-employment income – One reason for the overstatement of taxes you may owe is that the expenses you incurred in earning self-employment income are not considered. In preparing the Substitute for Return, only the gross proceeds received that were reported to the IRS by others are used in calculating self-employment income. You can deduct any necessary ordinary and reasonable expense you incurred in the production of income. These include the use of your car, materials and costs you incurred in earning this income.
Itemized Deductions – In calculating taxable income, you are generally allowed to claim certain deductions where these deductions are greater than the standard amount. Itemized deductions include mortgage interest paid, real estate taxes, state taxes paid, charitable contributions, medical expenses, job related expenses and other miscellaneous itemized deductions. In preparing the Substitute for Return, only the standard deduction will be applied.
Tax Credits – In calculating taxable income, you can often reduce your taxes by many available tax credits. The most common tax credits are the child tax credit, child care expenses and credits for educational expenses paid. In preparing the Substitute for Return, the available tax credits are not considered.
Adjustments – In calculating taxable income, you can often reduce your taxes by various adjustments. These adjustments include IRA contributions, moving expenses, self-employed health insurance premiums paid and more.
Penalties – Your projected taxes are further compounded by penalties for the failure to file your tax returns and the failure to pay your taxes when due. Penalties are based on the amounts you owe. Where the calculated taxes are overstated, the penalties owed are overstated as well.
Audit Reconsideration
Even if the IRS has prepared a Substitute for Return, you can prepare and file a corrected income tax return showing that the assessed taxes are greater than what you really owe and have your tax account reduced as a result, otherwise known as audit reconsideration.
If you still can’t pay your income taxes, you may have other options available to you, such as an Installment payment plan or an offer in compromise; where the taxes you owe can be settled for a far lesser amount. You can also request a delayed payment option on taxes you may owe.
Finding Out More Information
Many individuals believe that if they keep ignoring their tax problems, eventually it will all go away. Nothing can be farther from the truth. If the IRS believes you owe income taxes (especially where the taxes you owe may be substantial); sooner or later they will catch up with you to collect. Even if you’ve been successful by just ignoring the issue until now, this is not the best way to go.
Wouldn’t it be great if you could find out if the IRS thinks you owe taxes, for what years you owe, just how much you owe (or they think you owe), and if you owe – when can the IRS can no longer collect? Well actually you can – with no exposure!
Laws enacted by Congress will allow you to obtain this information under the Freedom of Information Act (FOIA) at little or no cost to you. You can even hire a CPA, tax attorney or enrolled agent to obtain this information for you confidentially without putting yourself at risk.
Who knows? Maybe you really don’t owe as much as you think. Maybe you don’t owe anything at all. Maybe, too much time has lapsed and the IRS can’t go after you. Or maybe you have a refund coming and you don’t even know about it.