If you haven’t filed tax returns in several years and have a filing requirement, you need to get into compliance. Section 7203 of the Internal Revenue Code requires tax returns to be filed. Failing to file tax returns and pay the tax due only leads to increased penalties and interest, as well as collection actions (such as wage garnishments, liens on your assets, and levies on your bank accounts), and added stress. It can even result in a misdemeanor conviction with imprisonment for up to one year.
However, absent actual fraud, the IRS is more interested in people filing tax returns and paying the tax than in seeking criminal convictions. Taxpayers can also lose a refund that they might otherwise have received if they fail to file their taxes on time. A refund is only allowed if it is claimed within three years from the date you filed your original tax return or two years from the date you paid the tax, whichever is later.
If you are not in compliance with your taxes, here are the tips to get you back on track. An experienced professional, like McDowell Law Group in Virginia Beach, can provide support and alleviate stress.
Step One: Determine What Tax Years Need a Tax Return Filed.
This step is more involved than taxpayers realize. The reasons for not filing are quite varied and the result of individual circumstances. It may have been so long since the taxpayer filed that they honestly don’t know when their last tax return was filed. Often, one spouse is primarily responsible for filing the couple’s tax returns. Upon the spouse’s death, the surviving spouse may simply not understand how to prepare and file a tax return. Still, other taxpayers stop filing due to medical conditions, for example, dementia. Even one’s death does not eliminate the requirement to file tax returns and pay the tax due.
If a taxpayer has not filed returns. The IRS likely sent notices to the taxpayer, such as Form CP59, Form CP15, Form CP16, or Form CP18, informing the taxpayer that they have a tax return filing requirement.
A taxpayer’s filing requirement can be determined by reviewing the taxpayer’s IRS Account Transcripts and Wage and Income Transcripts. These transcripts detail whether a taxpayer filed a return for each year and other account activity such as any tax payments made, what IRS notices were issued and income reported to the IRS.
Did the IRS Prepare a Substitute For Return (“SFR”)?
When tax returns are not filed, the IRS does not receive a response to the notices mentioned above, and the IRS may prepare a tax return for you, called a Substitute for Return (“SFR”). When the Substitute for Return is prepared, the IRS will then assess the tax liability in the amount they calculated. A Notice of Deficiency will be issued, informing you of the tax liability. If you do not respond to the Notice of Deficiency in 90 days, the IRS will take steps to collect the tax liability. Collection actions include wage garnishments, bank levies, and liens on property.
The SFR is prepared by the IRS using the tax information reported to them from third parties, such as your employer (on Form W-2); financial institutions (on Form 1099), or business income (often on Form K-1). The problem with the SFR is that you do not get the benefit of deductions you might be eligible for since these items are not all reported to the IRS. The SFR often results in a much higher tax assessment compared to a properly filed tax return.
If an SFR Was Prepared, Why File a Tax Return for That Year?
First, filing a tax return may result in a lower tax liability for that year, as mentioned above.
Second, taxpayers are not eligible for first-time penalty abatement for SFR tax years. (IRM 20.1.1.3.3.2.1(2)(b); you must be “in compliance” for first-time penalty abatement, but an SFR does not count as complying).
Third, the IRS only has ten years to collect an unpaid tax debt. This ten-year period is known as the Collection Statute Expiration Date (“CSED”). The CSED starts on the date that the IRS assesses the tax. The start date can be the original due date of the tax return or the date the tax return was actually filed. It can also be the date the SFR was prepared and the tax assessed.
Once the 10-year period expires, the IRS is barred from further collection actions for that specific tax debt (assuming there is no fraud involved). The debt is written off.
Filing a tax return for a tax year in which an SFR was prepared may restart the 10-year time period.
Determine the Tax Years the Taxpayer Did Not File and the IRS Did Not Prepare an SFR.
Tax returns for these years should be prepared and filed, but not before a thorough analysis of your tax situation is performed.
If a tax return has never been submitted, and the IRS has not prepared an SFR, the 10 years for collections never starts. The IRS can assess and collect outstanding taxes for those years.
However, the IRS only requires the prior six years of tax returns to be filed to be in compliance. (IRS Policy Statement 5-133; IRM 1.2.1.6.18) Enforcement for unfiled tax years greater than six years prior generally does not occur. So, if you filed tax returns for the last six years, you are considered in compliance.
Keep in mind that it is IRS policy, it is not the law. As stated above, if you did not file tax returns, the IRS, under the law, can enforce the filing requirement for years earlier than the immediate six years. But to do so, the IRS would have to prepare SFRs for those tax years to assess and begin collecting the tax due. Generally, the IRS will not prepare SFRs for years older than 5 years. (IRM 5.18.1.3.2.)
Step Two: Gather Your Prior Years’ Tax Information
In order to file your outstanding tax returns, you will need your tax information for each year. This includes W-2s, 1099s, investment information, K-1s, deduction information, etc. It is often the case that, if tax returns were not filed, tax records have usually not been retained.
Taxpayers can access their tax records and account transcripts online by establishing an account with the IRS. The wage and income transcript is a particularly helpful report. It is a record of the tax documents and information reported to the IRS each tax year tied to the taxpayer’s social security number. The taxable information reported to the IRS includes W-2s, 1099s, K-1s, etc. This information can be used to prepare your prior year’s tax returns – federal and state. An experienced tax professional in Virginia Beach can assist you in gathering this information.
Alternatively, you can file Form 4506-T with the IRS requesting wage and income transcripts and account transcripts.
For small businesses and self-employed individuals, a wage income transcript might not be as helpful. In that case, you might have to reconstruct your business records.
Step Three: File the Tax Returns
At this point, the filing requirement has been determined and relevant tax information has been gathered. Now you must file the required tax returns. Generally, the tax returns are prepared in sequential order in relatively short order. Be mindful of the Refund Statute Expiration Date.
Starting with the earliest tax year capital losses or operating losses need to be carried forward to future years.
Tax returns for the current and two previous tax years can be electronically filed. Tax returns older than that will have to be paper filed These returns should be mailed separately using United States Postal Service Certified Mail, with return receipt.
Determine if You Are Eligible For Penalty Abatement
There are methods for requesting abatement of penalties, none of which are automatic. For example, the first-time abatement might apply, or abatement for a reasonable cause.
First-Time Penalty Abatement
The penalties eligible to be abated under this policy are (i) failure to file penalty, (ii) failure to pay penalty, and (iii) failure to deposit penalty. To be eligible for abatement, you must comply, meaning you have to be current with your tax filing obligations. Abatement under this policy only occurs once and it will apply to the oldest tax year.
Reasonable Cause
For reasonable cause to exist, the taxpayer must have exercised ordinary care but was nonetheless unable to comply with their tax return filing requirement. It may be just as instructive to look at what is not reasonable cause. The following do not qualify as reasonable cause: (i) not having enough money to pay the taxes due or financial difficulty; (ii) not understanding the filing requirement; (iii) procrastination; (iv) reliance on bad advice from nontax professionals.
Step Four: Pay the IRS the Outstanding Tax Liability
If you have the ability to pay, then pay the tax due. If you cannot afford the tax due, then there are options available to avoid the IRS initiating collections against you.
Offer In Compromise
An Offer In Compromise is simply an agreement with the IRS where the IRS accepts a lower amount than the tax debt owed. Contrary to what many people think, this is not a negotiation. Specific criteria must be met to be eligible for an offer in compromise.
Installment Agreement
An installment agreement with the IRS allows you to pay your tax liability in monthly installments over time. Your monthly payment is based on a review of your assets and current income. The IRS will not take collection actions against you while you remain compliant with the installment payments. Interest will continue to accrue while you are paying your tax liability.
Partial Pay Installment Agreement
A partial pay installment agreement (“PPIA”) is an installment agreement with the IRS where you settle your tax liability for less than the full amount. This is not the same as an offer in compromise. With a PPIA, the taxpayer makes monthly payments to the IRS in an amount based on their ability to pay – much like a regular installment agreement. However, remember that the IRS only has 10 years from when the tax was assessed to collect (the Collection Statute Expiration Date or CSED). With a PPIA, the total payments under the installment agreement might not result in payment of the entire balance due before the CSED. Once the 10-year collection period ends, the taxpayer stops paying on the installment agreement and the remaining tax debt becomes uncollectible.
For example, assume a total tax liability of $50,000 and the IRS determines your monthly payment to be $300 per month (based on your income and ability to pay). If there are 84 months (7 years) left on the 10-year collections statute of limitations, then the total repayment to the IRS will only be $25,200 ($300 x 84 months) – almost half of the total tax debt (this does not factor in interest).
Currently non-collectible status
If you cannot pay based on your current earnings the IRS may put you in a non-collectible status. To qualify, you must demonstrate that paying the tax debt would prevent you from meeting basic living expenses. Your tax liability does not go away, but the IRS will not actively engage in collection efforts. Applicable penalties and interest will continue to accrue.
Take Control of Your Tax Future
Getting back into compliance after years of not filing tax returns may feel overwhelming, but it’s possible with the right approach. The IRS is primarily interested in taxpayers filing their returns and paying what they owe. By determining which years need to be filed, gathering the necessary documentation, preparing and submitting your returns, and exploring options for penalty relief or payment plans, you can take control of your tax situation and avoid escalating consequences. Whether you’re facing substitute returns, missing records, or a tax debt you can’t immediately pay, there are solutions available. Acting sooner rather than later not only reduces your stress but also protects your financial future.
Need help getting started in Virginia Beach? The experienced tax professionals at McDowell Law Group are here to guide you every step of the way. From reviewing your IRS transcripts to negotiating with the IRS on your behalf, we can help you get compliant with the state of Virginia. Contact us today to schedule a consultation and start your path toward compliance and peace of mind.