Substitute-for-returns procedure

Editor: Valrie Chambers, CPA, Ph.D.

If an individual fails to file a federal income tax return, Sec. 6020 authorizes the IRS to prepare that return. Typically, the Service determines returns are required to be filed based on the agency’s knowledge and available information from third-party reports, such as Form W-2, Wage and Tax Statement; Form 1099-INT, Interest Income; and Form 1099-DIV, Dividends and Distributions, issued to the person. It is called a substitute for a tax return but is treated as the return of the taxpayer. Regs. Sec. 301.6020-1(a)(2) states that a person for whom a return is prepared in accordance with Sec. 6020 shall, for all legal purposes, remain responsible for the correctness of the return to the same extent as if the person prepared the return.

Enforcement period

If returns have not been filed for several years, the agency generally will not use an enforcement period of more than six years, as found in Policy Statement 5-133 (Internal Revenue Manual (IRM) §1.2.14.1.18). However, the extent to which delinquency procedures will be enforced depends upon the facts and circumstances of each case. Enforcement for longer or shorter periods may be considered, given the taxpayer’s history of noncompliance, the existence of income from illegal sources, the effect upon voluntary compliance, and the anticipated revenue and its collectibility, in relation to the time and effort needed to determine the tax. Any special circumstances for the particular taxpayer or class of taxpayer, or that may be pertinent to the class of tax involved, may also be considered.

Notices sent to a taxpayer

The IRS campuses may issue notices requesting that returns be filed. Field examiners or revenue officers may contact taxpayers if they identify instances of nonfiling, typically from related or project cases, or referrals from other sources. A taxpayer can use the services of a federally authorized representative to represent him or her in this matter by providing a valid Form 2848, Power of Attorney and Declaration of Representative.

It behooves a taxpayer to respond to requests to file returns. If refunds are due because a taxpayer had withholding, estimated tax payments, or other credits, any refunds will not be made if they are requested after the statute of limitation has expired, which is normally three years after the extended due date of the return.

If returns are filed and the IRS does not agree with the tax reported on them, or if the IRS receives no response, a notice of proposed adjustment (30-day letter) is issued, which shows the computation of the tax and interest and any applicable penalties. The taxpayer has 30 days to respond by agreeing to the proposal, providing reasons as to why the adjustments are incorrect, or requesting a meeting with IRS Appeals. If a taxpayer has not responded to prior notices, the IRS may have an incorrect filing status, wrong amounts of income, and no record of any deductions or credits to which the person is entitled. The IRS campuses will make necessary changes to the proposed assessment if the taxpayer provides supporting evidence.

If no response is received or if the taxpayer cannot resolve the matter in Appeals, a statutory notice of deficiency (90-day letter) will be issued. The taxpayer may then agree to the proposed assessment or file a petition with the Tax Court within that 90-day period. The 90-day period is a strict one; if the 90th day falls on a Sunday or a holiday, the number of days is not extended to the next open business day.

When a taxpayer does not respond to the 90-day letter, an assessment is made using the information in the letter. A taxpayer can then file a return to report the correct tax. The IRS can accept or examine the return and, if warranted, adjust the assessment.

Other issues

If tax is due, the IRS will usually propose the failure-to-file and failure-to-pay penalties found in Sec. 6651. The penalties do not apply if the failure was due to reasonable cause and not due to willful neglect. IRM Section 20.1.1.3.2, Reasonable Cause, provides instances where reasonable cause may exist.

The first-time penalty abatement procedure will not apply if a return is filed after a taxpayer is contacted by the IRS.

If an assessment cannot be fully paid, a taxpayer should consider requesting an installment agreement payment plan or filing an offer in compromise.

The IRS will notify the department of revenue for the state where a taxpayer resides about unfiled returns, which may prompt the state to issue an assessment notice. To prevent additional accruals of interest and penalties, the taxpayer should file or amend state returns as soon as the federal tax is determined.