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How the IRS Treats Unfiled Tax Returns

April 30, 2015

What happens when you fail to file your tax return? First, you are charged the failure-to-file penalty of 5% of the taxes owed every month your return remains unfiled. Second, the IRS may file a substitute tax return to begin collection of back taxes.

The IRS files a substitute tax return or what the IRS calls a ‘Substitute for Return’ (SFR) to estimate how much a taxpayer owes. This estimate is based on information received from sources such as employers and banks.

The SFR only allows the standard deduction, one exemption, and the filing status of single or married filing separately (MFS). The SFR does not include any additional expenses, exemptions or credits that the filer may qualify for. This can lead to an inflated tax liability. Any penalties and interest charged on back taxes are based on the substitute return.

The IRS first issues a Proposed Individual Tax Assessment (Letter 2566 SC/CG) to notify the taxpayer of their assessment of the tax liability. The taxpayer has 30 days from the date on the letter to file their tax return or explain their position to the IRS. If the taxpayer does not respond, the IRS issues the statutory notice of deficiency.

A notice of deficiency (Letter 3219 SC/CG) informs the taxpayer that they have 90 days from the date on the letter to appeal to the U.S. tax court if they disagree with the IRS’ assessment of their tax bill. It also states that the IRS will assess penalties and interest on the back taxes based on their estimate.

The IRS assessment becomes final if the taxpayer does not file their own return with the qualifying credits, deductions and exemptions. In the absence of resolution efforts by the taxpayer, the IRS proceeds with collection action.

The agency can then:

  • Place a levy on the wages or bank accounts, or
  • File a federal tax lien against the property and/or assets of the taxpayer.

To avoid IRS collection actions, taxpayers should file their tax return after receiving communication from the IRS and pay any associated taxes.

An enrolled agent (EA), attorney, or a Certified Public Accountant (CPA) can assist a taxpayer with a resolution. Taxpayers that want professional help to resolve their case may hire a tax relief company or a tax professional.

 

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