Substitute For Returns

Substitute For Returns

Definition and Process

Investigation of Nonfilers

Delinquent tax returns can be identified and worked by the Examination Division, Collection Division, or the Service Center. Once a nonfiling situation has been identified, the IRM (Internal Revenue Manual) tells the assigned agent to review the situation for fraud. If there appears to be indications of fraud, the agent is instructed not to solicit returns or payment, but to refer the case to the Criminal Investigation Division. Assuming no indications of fraud, the IRS agent will contact the nonfiler and demand that he/she file all delinquent returns using Letter CP-515 and CP-518.

Substitute for Return (SFR) Preparation

If after proper notice the taxpayer fails to file the requested return(s), the matter will be referred to Automated Substitute for Return (ASFR) or the Examination Division for preparation of a return by the IRS under the authority of Internal Revenue Code §6020(b). There is no precise timeline for the IRS to prepare a return; sometimes the IRS is very slow and does not get around to filing the SFR until years after the return was due.

Impact on Balances, Refunds, Resolution of Case

If the IRS files a SFR, it is done based only on the information available in IRS computers. This typically results in a tax liability that is greater than if the taxpayer had filed his/her own return (also known as an “original” return or SFR Reconsideration Returns). The tax liability is artificially inflated because the IRS includes as income the gross proceeds of a sale (not the net proceeds after reduction for basis). The IRS allows the taxpayer only one exemption and the standard deduction (rather than itemizing deductions). Furthermore, the filing status used for SFR returns is typically single or married filing separate.

The Internal Revenue Code limits the time within which a taxpayer may obtain a refund of overpaid taxes. In general, a taxpayer must claim a refund within three years from the time a tax return is filed or two years from the time the tax was paid, whichever period expires later. For withheld taxes and estimated tax payments, these are deemed paid on April 15th of the year following the tax year in question. However, if no return is filed, a refund claim must be filed within two years of the date the tax was paid.

Non-filer cases typically take longer to resolve. And once an SFR is filed, the delays can be multiplied because processing of SFR Reconsideration Returns is not the IRS’s highest priority. However, failure to file an original return does not prevent a taxpayer from resolving his case. The IRS is usually willing to move forward if a taxpayer has no interest in preparing and filing his or her own return or cannot reconstruct the tax information necessary to prepare and file their return.