We always recommend that individuals and businesses file their tax return timely, even if they cannot make full payment with the return. One of the highest penalty rates imposed by the IRS is for the late filing of a return. The penalty is 5% a month, up to a maximum of 25%. One disadvantage to filing a timely return without payment is the IRS will begin the collection process sooner than if the individual late files a return. However, the additional cost of penalties for the time gained by late filing is excessive.
Alternatively, the late payment penalty, after notice, is 1% per month, or an actual rate of 12% per year in addition to interest.
Possible Criminal Penalties
Another reason to timely file a tax is return is the potential for criminal penalties for failure to file a tax return. Although the probability of prosecution for non-filing is not great, certain groups are targeted by the IRS, such as: tax protesters, lawyers, doctors, and other high income professionals.
Substitute for Return
If an individual has not filed a return, the IRS has authority to prepare a return on their behalf, known as a substitute for return (SFR). The SFR contains all information returns the IRS received from third parties, but does not allow for expenses, deductions, or other tax benefits. Therefore, the resulting tax balance on an SFR can be grossly overstated.
Identifying Non-Filer /Stopfiler
If an individual filed tax returns in the past and fails to file a return for the next tax period, that individual is known as a “stopfiler” by the IRS. If information documents, including W-2s and 1099s, are received by the IRS and do not match to a return, that individual is known as a “non-filer.” Most investigations for non-filing of returns are initiated due to computer matches of the “Stopfiler Program” and “Non-filer Program.”
The IRS will generally initiate research for a tax return about 15 months after it is due from a non-filer and nine months after the due date for stopfilers. Delinquency research is initiated eight to nine weeks after the due date of business returns, such as 941s.
The IRS shares information with state taxing authorities, allowing it to more efficiently determine non-filers and other tax oversights.
The Matcher program matches a taxpayer identification number (TIN) in an external file with those on Midwest automated compliance system (MACS). Its main purpose is to find non-filers.
Notice to File Return
Once a non-filer/stopfiler is identified, the IRS will usually send notices from the Service Center requesting that returns be filed. If the taxpayer fails to file in response to these notices, the IRS may prepare SFRs, attempt to call the taxpayer, or assign the case to a field officer. If the IRS determines a telephone call is the proper route, the taxpayer will be called by a representative from the Automated Collection System (ACS) and asked to file the return. If the taxpayer does not voluntarily file a return, an SFR may be filed.
The IRS generally issues four computer notices over a period of 26 weeks prior to a personal visit or a personal phone call. With business taxes, the IRS generally issues three notices spaced over a period of 22 weeks.
SFR/Notice of Deficiency
After an SFR is prepared and a tax due amount is assessed, a Notice of Deficiency will be issued to the taxpayer advising the taxpayer of the amount due. If the taxpayer does not file a return with 90 to 120 days (150 days if a taxpayer is overseas) after the Notice of Deficiency is issued, the tax is assesses based on the SFR calculation.
The following returns may be prepared, signed and executed by revenue officers under the authority without issuing a notice of deficiency to the taxpayer:
- Form 940, Employer’s Annual Federal Unemployment Tax Return
- Form 941, Employer’s Quarterly Federal Tax Return
- Form 943, Employer’s Annual Tax Return for Agricultural Employees
- Form 944, Employer’s Annual Federal Tax Return
- Form 720, Quarterly Federal Excise Tax Return
- Form 2290, Heavy Vehicle Use Tax Return
- Form CT-1, Employer’s Annual Railroad Retirement Tax Return
- Form 1065, U.S. Return of Partnership Income
Assigned to Field Office
If other methods fail to secure delinquent returns, the case will be assigned to a revenue officer for investigation.
When the IRS contacts a taxpayer about delinquent returns, the revenue officer will try to obtain enough information to make a tax determination, such as:
- income amounts,
- income sources,
- filing status,
- gross wages paid,
- withholding amounts, and
- bank accounts.
Through the information obtained from the taxpayer, the revenue officer will determine how next to proceed, e.g., SFR or summons.
Signs of Criminal Investigation
Any time a taxpayer has not filed a tax return, a tax practitioner should look for signs the case was referred for criminal investigation. One such sign is the presence of special agents of Criminal Investigation Division (CID) at the initial interview. Special agents carry a gold badge. If the taxpayer is interviewed by a special agent, they may be the subject of a criminal investigation. Revenue officers, tax examiners, or revenue agents carry photo identification. Also, if the taxpayer is read their “Miranda” warnings, it is very likely a criminal investigation. If the IRS has initiated a criminal investigation, the taxpayer should secure criminal tax counsel immediately.
An investigation of non-filing by a RO, TE, or RA may also become a criminal matter. All IRS agents can refer cases to the CID for prosecution. Typically, if the RO, TE, or RA do not set a deadline for filing a return, they intend to refer the case for prosecution.
In cases where the IRS representative believes fraud indicators are present, they will not:
- Ask for tax returns from the taxpayer,
- Give advice to the taxpayer, or
- Talk about referral possibilities with the taxpayer.
CID has 30 days to accept or decline a fraud referral.
The IRS representative may take the following actions to assist in establishing affirmative acts of fraud:
- Interview the taxpayer to determine the motive or intent for noncompliance.
- Notate the questions asked and the taxpayer’s response or lack thereof.
- Look for personal reasons that may affect the taxpayer’s ability to comply with the tax laws, including use of third party sources.
- Try to obtain a statement from the taxpayer regarding expenses not listed in the books and records, such as, expenses paid in cash or under the table payments to employees.
- Try to establish cash on hand at year end for each year under investigation.
The IRS will attempt to verify income from all available sources, including, but not limited to:
- Currency, Banking, and Retrieval System (CBRS) data;
- Information Data Retrieval System (IDRS) via: INOLE, IROLE, SUPOL, IRPTR, IRPOL;
- Copies of Forms W-2 from employers and Forms 1099 from customers;
- Copies of checks issued to the taxpayer from Form 1099 issuer(s);
- Review the taxpayer’s books and records of expenses and income;
- Review most recently filed tax return to identifying income sources, deductions, and exemptions; and
- Check public records for assets, visit the taxpayer’s residence, place of business, and/or other identified properties for use in determining if the taxpayer was able to pay the taxes at the time they were due.