Unfiled Tax Returns 101

If you are reading this you may not be current with your tax return filing obligations. As a tax attorney, I can say that individual taxpayers failing to file a tax return(s) is widespread. The IRS typically identifies more than 7 million non-filers* each year. I have met all types of taxpayers that for one reason or another have not filed income tax returns. This guide will help the non-filer get back into compliance.

*Source Treasury Inspector General For Tax Administration Report

What Happens If You Don’t File A Tax Return?

It depends. Are you required to file? Individuals with little or no gross income may not be required to file a return. The Form 1040 Instructions will include a section called “Who must file” or “Do you have to file?” and will inform the reader of filing requirements. I recommend filing a tax return even if not required. Filing a tax return does two things: (1) it creates a record of your compliance and (2) it starts the clock for statute of limitation purposes.

Best Practice: I recommend filing a tax return even if not required.

The IRS May File A “Substitute for Return” (SFR)

If a tax return is not filed the IRS may prepare a return for the taxpayer which is categorized as a Substitute for Return (SFR). The IRS is able to prepare a substitute for return based on information reported by 3^rd parties (i.e. W2s and 1099s). You do not want the IRS preparing your income tax return. The IRS will only generate a substitute for return if doing so will create a bill. Additionally, the tax due with the SFR may be overstated since the IRS will not take advantage of exemptions, credits, and deductions available.

Pro Tip: If the IRS files a Substitute for Return, it is usually in the taxpayer’s best interest to subsequently file a tax return to take advantage of all the exemptions, credits, and deductions.

Filing A Tax Return After Deadline (Filing Late)

Scenario I – Due a Refund (with return)

You won’t be penalized for failing to timely file your tax return if a refund is due. However, you may forfeit refund if tax return is filed more than three years after filing deadline (statute of limitations). The consequences of filing after the deadline will be felt by late filers with a tax return balance due.

Scenario II – Owe Taxes (with return)

If you owe tax and choose not to file by the filing deadline you will be subject to penalties + interest. The IRS calculates interest on the net tax due as of the filing deadline which accrues until the tax is paid (interest compounds daily).

Penalties

Failure to File Penalty – IRC Section 6651(a)(1)

The failure to file penalty is imposed on returns not filed by the filing deadline. The penalty is 5% of the net tax due per month that return has not been filed. The failure to file penalty cannot exceed 25%.

Failure to Pay Penalty – IRC Section 6651(a)(2)

The failure to pay penalty is imposed on the tax return balance due and unpaid by the filing deadline. The penalty is .5% or half of 1% for every month or part of a month that tax remains unpaid. The failure to pay penalty cannot exceed 25%.

Combined Penalties

When both penalties apply to the same balance, the failure to file penalty is reduced by the failure to pay penalty. Thus the combined penalty will not exceed 5% per month. Accordingly, the maximum combined penalty is 47.5% (22.5% late filing + 25% late payment).

Penalty Abatement

First Time Penalty Abatement

The penalties associated with filing a delinquent tax return with a balance due can be substantial. However, if this is your first time not being in tax return filing compliance you may qualify for first time penalty abatement. In order to qualify for first time abatement the following must be true:

- Taxpayer has not been assessed a penalty on the three previous filed tax returns.
  - To illustrate, a taxpayer requesting first time penalty abatement on a 2018 tax return must not have been assessed a penalty on his 2015, 2016, or 2017 tax returns.
- Taxpayer has filed all required returns or filed an extension of time to file.
- Taxpayer has paid, or arranged to pay, any tax due.

Reasonable Cause

In addition to first time penalty abatement, a taxpayer who has failed to timely file may request penalty relief based on reasonable cause. The Internal Revenue Manual [IRM 20.1.1.3.2] states reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but was nevertheless unable to comply with those obligations.

IRS Past Due Tax Return Notices

If you have past due unfiled income tax returns you may have received one of the following notices:

CP59 Notice: The IRS mails this notice to certain taxpayers when there is no record that the taxpayer filed an income tax return.

CP63 Notice: The IRS mails this notice to taxpayers who are expecting a tax return refund but have other unfiled tax returns. The IRS is informing the taxpayer their refund will be held until the taxpayer files past due tax returns.

CP259 Notice: The IRS mails this “reminder” notice to taxpayers who are required to file a tax return but have not.

CP515, CP516, CP518I: These 3 notices are more “reminder” notices instructing taxpayers to voluntarily file a past due tax return.

CP2566 Notice: This notice informs taxpayer that since the IRS has not received a tax return from taxpayer, the IRS has calculated a tax, penalty, and interest due based on information reported to IRS by 3rd parties. – see “Substitute for Return” below.

CP3219N Notice: This is a Notice of Deficiency and once received a taxpayer has 90 days to petition tax court.

Delinquent Return Refund Hold Program (DRRH)

The Delinquent Return Refund Hold Program is in place to hold individual income tax refunds in situations where taxpayers have unfiled tax return(s) within the prior five tax years. The taxpayer will receive an IRS letter (Notice CP63) directing him/her to file the delinquent return(s) or explain why there is no filing requirement. Additionally, the letter will inform the taxpayer that if tax return(s) are not filed, the IRS may file the return(s) for the taxpayer (Substitute for Return).

Understanding Statute of Limitations + Unfiled Tax Returns

There is no statute of limitations preventing the IRS from examining a year when a tax return was never filed. There is a statute of limitations preventing taxpayers from receiving a tax return refund. A taxpayer that would be due a refund must file a tax return to claim a refund within 3 years of the filing deadline or alternatively two years from the date the tax was paid. It is for this reason that priority should be focused on tax returns with refund potential within 3 years of the filing deadline.

How To Prepare Prior Year Tax Returns?

In many cases, the taxpayer will no longer have the necessary tax documents needed to prepare a prior year return. In a situation like this, it is essential to request information from the IRS. Taxpayers may request a Wage and Income Transcript from the Internal Revenue Service this transcript will provide much of the needed information necessary to prepare a tax return including data from W-2s and 1099s. The Wage and Income transcript is available for the prior 10 years.

Pro Tip: I do not recommend preparing prior year tax returns without a wage and income transcript. Even if you believe that you have all the documents needed to prepare a complete and accurate tax return, requesting a transcript will ensure nothing is missed and prevent the chance of receiving a tax notice.

How Many Years Of Unfiled Tax Returns Should Be Filed?

The IRS generally will not enforce tax return compliance for periods in excess of six years. As a result, non-filers that want to be “current” with the Internal Revenue Service will file the most recent six years of income tax returns. Note: IRS may enforce compliance in excess of six years based on facts and circumstances.

How To File Past Due Returns With IRS (E-File & Paper-File)

Once prepared the prior year tax returns will need to be filed with the IRS. The most recent three years of returns may usually be electronically submitted or e-filed with the IRS; and the older returns paper-filed and mailed to the IRS. Go to where to file paper tax returns for a correct and up to date mailing address.

Pro Tip: When mailing multiple years of returns it is recommended to mail each tax return in a separate envelope.

New York State Considerations

If you are filing an income tax return with the IRS be aware that you may also be required to file a state tax return. New York State has a Voluntary Disclosure Program (“VDP”) that allows eligible non-filers to come forward and file back taxes. Taxpayers going through the VDP will not be subject to penalties or charged criminally (a nice incentive for non-filers). Learn more about the New York State Voluntary Disclosure Program.

Unfiled Tax Return Help

Alizio Law is unique being a law firm that offers in-house tax return preparation a benefit to clients in non-filer situations. Peter E. Alizio is a dual practitioner working as a CPA in tax compliance and a tax attorney focusing on tax controversy resolution. Peter has over 10 years of experience preparing tax returns and can help you with past due unfiled return(s).

If you need further assistance, please contact us at (212) 520-2906.