The Substitute Return: When the IRS Files Unfiled Returns For You

If you fail to file your tax return when you have a legal obligation to do so, the IRS can use the Substitute for Return (SFR) procedure to file it for you. There are several disadvantages to this scenario from a taxpayer’s perspective, and you should take action immediately upon receiving a notice that you haven’t filed your tax return.

First, the IRS will file your return based on reported information from your employers or businesses that paid you as an independent contractor, usually from W-2 or 1099 forms. However, the IRS has no way of knowing what deductions, exemptions, credits, or losses you are eligible to claim your tax return. Therefore, they will not give you credit for any of these amounts that could substantially reduce your tax liability.

Second, the failure to file a tax return is one of the badges of tax fraud, and the IRS may scrutinize a taxpayer who fails to file a return for other indications of tax fraud. This can result in civil tax fraud penalties of 75% of the amount of tax owed, or criminal tax fraud charges, that could result in more fines or jail time.

Before filing the SFR, the IRS will attempt to get a taxpayer to file the return voluntarily. If you fail to do so, the IRS will file the SFR and send you a notice of deficiency. You will have 90 days to petition the Tax Court if you want to contest the amount due.  While you can just file a tax return instead there is no guarantee that the IRS will agree to accept the tax return. That is why our tax attorneys rarely recommend NOT filing a Tax Court petition.

If you do not file a petition, then the IRS may begin the collections process. At some point you may receive a notice that your bank account is going to be levied, or that a portion of your wages is going to be garnished.

Failing to file a tax return is one of the biggest mistakes a taxpayer can make. The failure to file penalty is much greater than the failure to pay penalty, and an SFR can result in a greater tax liability than you would if you filed your own return.

The statute of limitations also does not begin to run until you file your tax return, so failing to file gives the IRS an unlimited amount of time to collect tax debt from you. Finally, if you are owed a refund for a return, you must file it within three years of the return due date, or you forfeit your refund to the U.S. Treasury.

If you receive an SFR notice, do not ignore it. Contact a tax attorney to discuss how you can minimize tax penalties and reduce your tax debt.