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Unfiled Tax Returns
IRS Failure to File Compliance:
Most non-filing investigations of taxpayers initiated by the IRS are based upon computer matches. The IRS uses both a "stop filer program" and a "non-filer program" to discover return delinquencies. If a taxpayer has filed tax returns in the past and then a return is not filed for the next tax period, that taxpayer is identified as a "stop filer". If IRS received information documents (such as Forms W-2 and 1099) which reflect reportable income and no return has been filed then that taxpayer is identified as a "non filer".
Normally the IRS will initiate a non-filing check 15 months after a Form 1040 (Individual Income Tax Return) is due from a "non-filer" or 4 months after the due date for a "stop filer". In the case of business taxes and payroll taxes, such as Form 941 employment tax returns, an IRS delinquency check begins 8 weeks after the due date of a return.
Normally the IRS will attempt to secure returns from "non filers" and "stop filers" by sending Service Center notices requesting that returns be filed. If the taxpayer fails to file despite the computerized notices, the IRS may follow up in several different ways. It may prepare tax returns for the taxpayer based upon information documents it has received from institutions and employers. It may attempt to contact the taxpayer by telephone or it may assign the matter to a Revenue Officer for field investigation.
The Internal Revenue Service delinquency check will normally result in the IRS issuing four (4) computer notices regarding Forms 1040 over a six (6) month period. In the case of business taxes, such as Form 941 for employment taxes, the Internal Revenue Service will normally issue three (3) notices spaced over a period of 22 weeks. IRS collection representatives become involved after the notice phase is completed.
Criminal Non-Filing:
Failing to file returns is a criminal misdemeanor in the federal system. In some instances, failing to file can be prosecuted as a criminal felony. Certain individuals are more likely to be prosecuted by the IRS than others. The complete guidelines regarding criminal non-filing are contained in the Internal Revenue Manual. Here is a partial list of non-filers of interest to the IRS Criminal Investigation Division:
- The non-filing involves known organized crime figures and persons alleged to be receiving graft or income from illegal sources.
- The taxpayer's occupation and education denote prima facia evidence of knowledge concerning his/her filing obligations. Examples include public officials, attorneys, accountants, stock brokers and business executives.
- The non-filer is a tax protester.
In instances where a taxpayer has failed to file returns, he should be alert for indications that the IRS has referred the matter for IRS criminal investigation. If the IRS representative identifies himself as a "special agent", has a gold badge with the words "Criminal Investigation Division" or gives the taxpayer his "rights against self incrimination", that taxpayer should not speak with the IRS representative but should immediately seek legal counsel.
Failure to File Strategies:
For most taxpayers, the act of non-filing is a creditor/debtor issue. The IRS, however, is an extremely aggressive creditor with broad ranging statutory powers to collect tax deficiencies. Unlike regular civil cases and ordinary debt, the IRS need not reduce the tax debt to civil judgment in a court of law; rather the IRS need only rely on the fact that a tax deficiency has been assessed, the taxpayer has been properly noticed of the tax deficiency and noticed of the IRS' intent to levy (a registered letter). The taxpayer must also have failed to pay the tax assessment. Once these prerequisites exist the IRS, as sanctioned through federal statute, may seize and levy upon taxpayer's property. The information in this paragraph presumes the IRS has created a substitute tax return for the non-filer from internal records.
The non-filing client is perhaps the most common IRS collection/controversy problem encountered by tax practitioners. If the tax practitioner is an accountant, the accountant must determine whether the taxpayer has criminal exposure for failure to file returns which is a misdemeanor, or for tax evasion which is a felony. Usually the exposure is there. It is always advisable to refer the client to an attorney in order to protect the client with the attorney-client privilege. An attorney's involvement with a case and initial contact with the IRS can negate IRS interest in a criminal prosecution.
Delinquent returns must be prepared and filed. The question usually arises as to what is the best way to file these returns. There is no single answer to this question although the ultimate goal is always to file the returns. Filing is always a more financially attractive alternative than letting the IRS prepare the returns from internal records. It is possible that an IRS prepared substitute return assessment can be reduced by filing an original return. Additionally, unfiled tax returns do not have a collection statute of limitations.
Many clients come to tax practitioners at the last possible moment, usually under aggravated circumstances. Their wages have been garnished or the IRS has levied their bank account. The wage levy in particular has disastrous effects on the employer/employee relationship and the taxpayer's cash flow. A wage garnishment is a "continuing levy" and will not be removed until the taxpayer takes affirmative action in dealing with the IRS. Filing returns is usually a prerequisite to a release of an IRS levy.
Clients are frequently confronted with the following question: "Should I file the return right now, or wait until I have the money to pay for it?". The answer is very simple. The return or returns should be filed as soon as possible. If the client has any funds available for payment, a check should be enclosed with the return. The reason is that non-filing clients are facing one of the highest penalty rates which the IRS is allowed to impose. The failure to file penalty rate is 5% per delinquent month up to a maximum of 25% of the tax due but unpaid by the due date of the return. Filing a timely return without payment, on the other hand, only results in a late payment penalty, which ranges from .05% to 1% per month. In all cases the IRS will add interest at the statutory rates.
Filing a return without full payment will result in a lower tax/penalty assessment than non-filing or late filing. The IRS is generally favorable to entering into an installment agreement arrangement to pay back taxes on late filed returns. Installment agreements are discussed elsewhere on this website.