Unfiled Tax Returns
The IRS estimates that each year approximately ten million people fail to file their federal income tax returns. The reasons that taxpayers fail to file their tax returns are varied; some taxpayers simply procrastinate; others don’t understand their filing requirement; and in a few cases, taxpayers willfully fail to file in an attempt to evade their responsibility to report their income and pay their tax liability. The IRS uses the same term to describe all of these taxpayers, “Non-filers.” In most instances, the problems faced by Non-filers can be resolved successfully if the taxpayer obtains experienced legal counsel and voluntarily addresses the problem. On the other hand, the continuing failure of a taxpayer to voluntarily comply with tax return filing and to obtain experienced legal counsel can result in severe consequences. In some cases, a taxpayer may even suffer a criminal tax prosecution.
For many years, the IRS lacked the budget and the ability to identify and find habitual non-filers. However, the IRS has substantially increased its budget for technology that will enable it to find and pursue taxpayers who fail to regularly file their returns. The IRS has targeted the problem of non-filers as one of its highest priorities. The IRS has developed and continues to improve sophisticated computer matching software programs designed to identify and locate these taxpayers. IRS computer capabilities are constantly being improved to enable the IRS to match third party income and expense information to returns (or the lack thereof) of taxpayers, and the IRS is becoming increasingly adept at identifying and locating non-filers. If you have not filed all required tax returns, and have not yet been discovered by the IRS, the time to act is now. If you fail to act now, the IRS is almost certain to knock on your door in the future. It is a misdemeanor to willfully fail to file your tax return. This could lead to a one-year maximum sentence. If charged with the felony of tax evasion, you may face five years of imprisonment. It is not worth taking that chance.
IRS Non-Filer Program
Between the late 1990’s and 2004, the IRS conducted an intensive research program of non-filers. This study resulted in an IRS determination that approximately ten million taxpayers annually fail to file their income tax returns. In response, the IRS created a joint task force of revenue agents and tax auditors from the IRS Examination Division, Revenue Officers from the Collection Division, and Special Agents from the Criminal Investigation Division to locate non-filers and secure compliance with filing requirements. Although the task force secured a number of delinquent tax returns, it did not substantially reduce the number of taxpayers who regularly fail to file their tax return. The IRS continues to make the non-filer problem a high priority and continues to develop its ability to locate these taxpayers.
The IRS Information Reporting System (IRP) is a multi-task system including a subsystem used to discovery of under-reporting of income and non-filers. This subsystem is the backbone of the IRS effort to identify and locate Non-filers. The “Non-filer” subsystem program matches information documents such as W-2’s and 1099’s to the information reported by the taxpayer and is most responsible to discovering most non-filers. Depending on the filing requirements, information documents are submitted by the payers and receivers to governmental agencies. In addition, this subsystem is used in the IRS “Stop-filer” program to identify taxpayers who have filed returns in the past, but have failed to file returns for the current tax year.
In many cases, if a taxpayer addresses his or her tax problem before an IRS criminal investigation has begun, it is possible to use the IRS’s “voluntary disclosure” policy to file missing returns and avoid prosecution. Most recently, the IRS made changes in connection with its voluntary compliance program in an announcement made on December 11, 2002. In connection with the voluntary compliance program, the taxpayer must be careful to file returns that are fully accurate and truthful. If the IRS determines that late filed returns are false, the chances of criminal prosecution increase tremendously. The IRS’s voluntary disclosure policy applies to a taxpayer who:
- Voluntarily informs the IRS of his failure to file for one or more years
- Had income from only legal sources
- Makes the disclosure prior to being informed that he is under criminal investigation
- Files a correct tax return or cooperates with the IRS in ascertaining his correct tax liability
- Makes full payment of the amount due, or if unable to do so, makes bona fide arrangements to pay
The filing of a delinquent return is different than the filing of a timely return and requires an extra level of care and accuracy. It is important to move quickly and correctly. If handled properly, the problem can be resolved successfully. If handled in the wrong way, the chances of criminal prosecution increase.
Once the IRS identifies and locates a non-filer or “stop-filer,” the IRS begins to send a series of notices requesting that delinquent returns be filed. Usually, the IRS will send a series of four computer-generated notices (often referred to as CP Notices) to the taxpayer prior to investigating the taxpayer by personal visits or telephone contact. Individual taxpayers receive these CP Notices over a 26 week period, while business taxpayers normally receive at least three notices during a 22-week period. If the taxpayer fails or refuses to respond to the computerized notices, the IRS uses a variety of methods to force compliance. The IRS may prepare its own tax return for the taxpayer based on third party documents and information returns filed with the Service. It may also attempt to contact the taxpayer by telephone or assign the case to a Revenue Officer for field investigation.
If telephone contact is warranted, the case will be assigned to the Automated Collection System (ACS). Once contacted by ACS personnel, the taxpayer will be asked to file his or her delinquent returns. ACS employees may also contact neighbors, employers, and others in an attempt to secure information about the taxpayer’s potential tax liability. Once the IRS secures adequate information about a Non-filer’s income and the taxpayer fails to voluntarily file a return, the IRS will often prepare its own Substitute for Return (SFR) on behalf of the taxpayer.
Substitute for Returns
Substitute For Returns are prepared and filed pursuant to Authority granted the Internal Revenue Service by IRC §6020(b) which authorizes the IRS to prepare an individual income tax return on behalf of the taxpayer. In most cases, the Automated Substitute for Return (ASFR) system is used to evaluate the IRS Master File (MF) information about the taxpayer, and prepare an SFR for a wage earner or taxpayer without other unresolved taxpayer delinquent accounts (TDA). In order to conserve manpower and financial resources, cases having the following criteria will generally be handled by the ASFR system: (1) The taxpayer is not self-employed; (2) total income is less than $100,000; (3) the income shown on the IRS Information Reporting System totals more than 75% of adjusted gross income and total positive income on the taxpayer’s last filed return; (4) the tax year is no older than six years prior to the current tax year; (5) there is no current or pending “uncollectable status” on the account; and (6) the taxpayer’s address has been verified. If these conditions do not exist, the matter will be sent to a Revenue Officer to review and obtain pertinent information prior to referral to the Examination Division for creation of a Substitute for Return for the taxpayer.
If the IRS discovers a habitual Non-Filer before voluntary disclosure, either through its own non-filer programs or through an informant, the IRS will often refer the matter to the Criminal Investigation Division (CID) to determine if criminal prosecution is warranted. The IRS has devoted substantial resources to identifying non-filers. Most often, the IRS Criminal Investigation Division targets “high-impact” individuals, taxpayers that habitually file “non-processable returns” and “Tax Protesters” for criminal prosecution. IRS special agents assigned to CID also evaluate the information obtained in their investigation to identify certain activities, called “badges of fraud,” that may indicate criminal tax fraud.
Attorney Client Privilege
Individuals with unfiled tax returns often begin seeking help by contacting their accountant. Federal and state laws recognize a limited accountant-client privilege concerning confidential communications. However, the privilege or confidentiality rules involving discussions between a client and an accountant do not apply to criminal cases. Only the attorney-client privilege survives a state or federal criminal investigation or prosecution. This privilege is often a critical component in representing and defending a taxpayer with unfiled returns or unpaid taxes.