An SFR is a Substitute for Return – a Form 1040. It is a tax return that the IRS files on the behalf of a taxpayer that failed to file his/her tax return. If you are required to file and you do not, the IRS will determine if a SFR will be prepared in order to calculate the unpaid taxes.
Estimating a filer’s tax liability is the first step towards the collection of back taxes. To determine how much in taxes an individual owes, the IRS reviews various financial information, including income reported on W-2s, 1099-MISC, and 1099-INT. The IRS also uses information from third parties, including employers and banks, to calculate the total income. The final amount is calculated based on the total income minus the withheld taxes.
It is important to note that the IRS only calculates income on an SFR, not the deductions, credits or exemptions that the taxpayer qualifies for. Therefore, an SFR will likely show the taxpayer owing a greater amount in taxes.
The IRS prepares an SFR in a very basic manner. Even if you could have filed a joint return and saved on taxes, the IRS will treat you as an individual. This may not be to your advantage.
The IRS adds penalties and interest to the total back taxes owed. Penalty for non-filing of a return is 5% and the penalty for non-payment of taxes is 0.5%. Penalties are incurred every month. The interest charged is the federal short-term rate plus 3% for a year. It is compounded daily.
The IRS has to prepare hundreds of SFRs each year, and they may file one long after the due date on your return. If the IRS files an SFR after several years, the total tax debt increases substantially due to the accumulation of penalties and interest.
The IRS sends many letters to a non-filer, informing the taxpayer that they have not received a tax return. It is only after the taxpayer does not file, ignoring these notices, that the IRS files an SFR to begin collection.
A taxpayer can file his/her return after the IRS has filed an SFR, and claim deductions and credits to lower their tax bill. The penalties and interest, however, apply unless the taxpayer qualifies for penalty abatement.