Unfiled Tax Returns

Falling behind on tax returns can happen for many reasons. A taxpayer may have missed one filing deadline during a difficult year and then found that each additional year made the problem harder to address. Records may be missing, a business may have closed, investment transactions may need to be reconstructed, or the taxpayer may simply be uncertain about where to begin.

Whatever caused the filing problem, unfiled tax returns generally become more difficult to resolve with time. The IRS may continue receiving information about your income from employers, financial institutions, brokerage firms, retirement plans, and other payers even when you do not file a return. Eventually, the IRS may contact you about the missing return and, in some cases, determine a tax liability based on the information available to the government.

The important point is that being several years behind does not mean the situation cannot be fixed. The first objective is to determine which returns are actually required, reconstruct the information necessary to prepare them accurately, and bring the taxpayer back into filing compliance. Only then can the resulting tax balances and appropriate collection options be evaluated properly.

What Happens When You Don’t File a Tax Return?

If the IRS believes that a required return has not been filed, it may begin a delinquent-return process and send notices requesting the missing return. Depending on the circumstances and how far the case progresses, the IRS may eventually prepare what is commonly known as a Substitute for Return, or SFR.

A Substitute for Return is not the same as the taxpayer preparing and filing an accurate original return. The IRS generally constructs the proposed liability using income information available to it, such as Forms W-2 and 1099. That calculation may not reflect all of the deductions, credits, basis information, expenses, or other tax treatment that would be reported on a properly prepared return.

For example, brokerage proceeds reported on Form 1099-B may require cost-basis information to determine the actual taxable gain or loss. A self-employed taxpayer may have legitimate business expenses that need to be reconstructed and reported. Filing status, dependents, credits, capital transactions, rental activities, and other circumstances can also materially affect the correct tax liability.

If the IRS proposes a tax assessment through the Substitute for Return process, it may issue a Notice of Deficiency giving the taxpayer a limited period to respond or petition the U.S. Tax Court. If no appropriate action is taken, the IRS can assess the proposed tax and begin collecting the resulting balance.

Even if the IRS has already prepared a Substitute for Return, however, filing an accurate taxpayer-prepared return may still be important. In many cases, the IRS can adjust the account based on the properly filed return and the taxpayer’s actual tax information.

Unfiled Returns, Penalties, and IRS Collection

When an unfiled return ultimately shows a balance due, filing and payment penalties and interest may substantially increase the amount owed. The longer a filing problem remains unresolved, the more complicated the overall tax situation can become.

But filing the return and paying the balance are two separate issues.

A taxpayer who cannot afford to pay several years of taxes in full should generally not continue leaving the returns unfiled simply because payment is impossible. The IRS specifically instructs taxpayers to file past-due returns even when they cannot pay the entire amount due. Once the required returns are filed and the actual liability is known, the taxpayer can evaluate the available collection alternatives.

Depending on the circumstances, those alternatives may include an Installment Agreement, Currently Not Collectible status, an Offer in Compromise, or another resolution. Penalty relief may also be available in appropriate cases. The available options depend on the taxpayer’s filing history, financial circumstances, type of liability, collection status, and other facts.

Filing compliance is particularly important because missing returns can prevent or complicate many IRS collection resolutions. Before trying to negotiate a long-term solution for an existing tax debt, it is therefore often necessary to determine which returns the IRS requires and bring those filings current.

If assessed balances remain unresolved after returns have been filed, the IRS collection process may eventually include a Notice of Federal Tax Lien, bank or wage levy, or other enforcement action. Addressing the missing returns before the case reaches that point generally provides more time to understand the liability and develop an appropriate resolution strategy.

What If You Are Missing Your Tax Documents?

One of the most common concerns we hear from taxpayers with several years of unfiled returns is: “I don’t have the records anymore. How can I possibly file?”

Missing documents do not necessarily mean that the returns cannot be prepared.

We can obtain and review IRS transcripts to determine what information has been reported to the IRS for the years involved. Wage and income transcripts may contain information from Forms W-2, 1099, and other information returns filed under the taxpayer’s Social Security number or taxpayer identification number. Account transcripts can also help establish whether the IRS has already made an assessment, prepared a Substitute for Return, issued certain adjustments, or taken other actions on the account.

IRS transcripts, however, are not always a complete replacement for the taxpayer’s own records. A transcript may show that income was reported without providing all of the information necessary to calculate the correct tax treatment. Brokerage transactions may require historical cost basis. A business owner may need bank statements, bookkeeping records, receipts, mileage information, or other documentation to reconstruct deductible expenses. Real estate transactions may require purchase and sale documents, improvement records, or depreciation information.

For this reason, preparing delinquent returns often involves both obtaining IRS records and reconstructing information from other available sources.

The objective is not merely to submit forms to the IRS. It is to prepare supportable tax returns that reflect the taxpayer’s actual circumstances as accurately as the available records permit.

How Many Years of Unfiled Returns Need to Be Filed?

Taxpayers who have not filed for many years frequently assume that every missing return must automatically be prepared before they can resolve their IRS problem. That is not necessarily the correct starting assumption.

The filing requirements should be evaluated based on the particular taxpayer’s circumstances and current IRS compliance requirements. Factors can include which returns were legally required, what years the IRS is requesting, whether Substitute for Return assessments already exist, the taxpayer’s filing history, and whether older years involve refunds or other issues that still need to be addressed.

This is why we prefer to review the taxpayer’s IRS records before simply preparing a stack of returns based on assumptions.

There is another reason not to delay the review: refunds do not remain available indefinitely. A taxpayer who was entitled to a refund from withholding, estimated payments, or refundable credits can lose the ability to claim that money if the applicable refund statute expires. For many taxpayers, the practical filing window for claiming a refund is generally three years from the original return due date, although the precise statute should be evaluated based on the circumstances.

Consequently, an unfiled return does not always mean that the taxpayer owes the IRS. Some missing returns may produce refunds, while others may produce balances due.

What If the IRS Has Already Filed a Substitute for Return?

A Substitute for Return changes the posture of the case, but it does not necessarily mean that the IRS’s assessment represents the taxpayer’s correct liability.

When reviewing an SFR case, we first need to understand what the IRS assessed and what information it used. We then compare that assessment with the tax return that should have been filed based on the taxpayer’s actual circumstances.

The difference can sometimes be significant - The taxpayer may have deductions, credits, cost basis, business expenses, a different filing status, or other information that was not reflected in the IRS’s proposed calculation. Preparing the correct return may therefore reduce the assessed liability in appropriate cases.

At the same time, an SFR case should not be approached with the assumption that filing a return will always reduce the balance. The correct result depends on the facts. Our objective is to determine the accurate tax liability and then address the remaining collection problem based on that amount.

How PLUS/AUDIT Can Help

When we begin an unfiled-return case, we first determine the scope of the filing problem. With proper authorization, we can obtain and review available IRS transcripts, identify missing tax years, examine income information reported to the IRS, and determine whether the IRS has already made assessments or initiated Substitute for Return procedures.

We then identify what additional records are necessary to prepare the returns correctly. Depending on the case, this may involve W-2 income, brokerage transactions, self-employment activity, rental property, retirement distributions, real estate transactions, business records, or other tax information.

Once the required information has been assembled, we prepare the delinquent returns and determine the taxpayer’s actual federal tax position for each year. If the completed returns result in balances that cannot be paid in full, the next step is to evaluate an appropriate collection resolution.

That distinction is important. Preparing missing returns solves the filing-compliance problem; it does not necessarily solve the tax-debt problem. Our goal is to address both when both are present.

A taxpayer who becomes filing-compliant may have substantially more options for resolving the remaining IRS debt than a taxpayer who continues to have delinquent returns.

If you have one or several years of unfiled federal tax returns, have received an IRS notice concerning a missing return, or believe the IRS may have prepared a Substitute for Return, the situation should be reviewed before additional enforcement action occurs.

PLUS/AUDIT TAX P.C. assists individuals and businesses in Colorado and throughout the United States with delinquent tax returns, Substitute for Return cases, and related IRS tax resolution matters.