By Deborah J. Weber

For various reasons, you may not have filed your federal income tax return for this year or previous years. You may not have filed because you expected a refund and you just haven’t taken the time to complete the return to claim it. You may not have filed because you owed additional tax that you couldn’t afford to pay in full. You may not have filed because of some problem or tragedy that occurred. Often, when a person does not file for one year, it escalates into several years. Getting back into compliance may not be as difficult as you fear. The key is to take the first step in the right direction, and then continue one step at a time.

Whether you haven’t filed for one year or many years, the first step is to gather all of the information necessary for the preparation of the outstanding returns. If you are in possession of your income and expense information, all of this should be organized and provided to your return preparer. If you do not have all of your information, the Internal Revenue Service can often provide you with what is referred to as a “payor transcript”, which is a record of all payor information which is filed with the IRS. This often includes W-2s, 1099s, mortgage interest, etc. Once the payor information is obtained from the IRS, it can be used to prepare the outstanding returns. Once the returns are prepared, they should be filed with the IRS (and the state taxation agency of the state in which you reside).

If a tax liability will arise as a result of the filing of outstanding returns, and if you are unable to full pay the liability, the IRS may allow you to enter into an installment payment agreement. Generally, the IRS has 10 years to collect an outstanding tax from the date the tax is assessed. However, in some circumstances, the IRS will allow taxpayers to compromise their liabilities if the taxpayer can establish that he or she does not have sufficient income and assets to pay the liability within a reasonable period of time. The calculation of “reasonable collection potential” is complicated and beyond the scope of this article. However, if you have a tax liability that you believe you are unable to pay and are interested in the submission of an offer in compromise, you should contact a tax professional.

If you have unfiled returns and believe that you are entitled to refunds due to federal tax withholding or estimated tax payments made throughout a calendar year, it is important to remember that there is a limited period of time for you to obtain a refund of money that you overpaid. All federal tax withholding that occurs throughout a calendar year is considered paid to the Internal Revenue Service on April 15th of the year following the calendar year in issue. A taxpayer has the later of three years from the due date of a return or two years from the date a tax is paid to make a claim for refund. Failure to make a claim for refund within the prescribed period of time will result in a denial of the claim and loss of the refund.

Another factor to take into consideration when preparing outstanding returns is the filing status. Many professional return preparers automatically file tax returns for married individuals as married filing joint, presuming the liability will be lower because of the benefit of the joint filing rates. However, if the liability reflected on outstanding returns is so large that the couple will never be able to pay it, consideration to filing married filing separate should occur prior to filing the tax returns with the IRS. One strategy may be to limit the tax liability to one spouse with the other spouse not having a tax liability. In doing so, it may be possible to protect some marital assets and the individual assets of the person without the tax liability. However, it is important to do this analysis prior to filing since once a married filing joint return is filed with the IRS, it cannot be undone.1

Often, people do not file their tax returns on a timely basis because they are not able to full pay the liability. However, this is a tragic mistake since the failure to file penalty will achieve its maximum 25% within five months of not filing a return on time (5% of unpaid tax per month), where the failure to pay penalty does not achieve its maximum percentage for twelve and a half months (½ of a percent per month). If you have a tax return that reflects a tax you are unable to full pay, the return should still be filed on a timely basis with a request for an installment payment agreement. By doing this, the failure to file penalty is avoided completely and, depending on how quickly you can pay the outstanding liability with the payment agreement, some portion of the failure to pay penalty may also be avoided. Finally, both penalties can be abated if you can establish “reasonable cause” for the failure to file or failure to pay. However, reasonable cause exists in limited circumstances, and most of the case law on what constitutes reasonable cause goes against the taxpayer.

What will happen if you don’t file your outstanding returns? Generally, the IRS will send you a letter requesting that you file the return(s) and will likely send this letter request two to three times to give you an opportunity to voluntarily file your returns. However, if you continue not to file your outstanding returns, the IRS has the authority to prepare an income tax return on your behalf, pursuant to IRC §6020(b). If the IRS prepares a return for you, this is often referred to as a “substitute for return”. When the IRS prepares a substitute for return, it will again mail it to you and ask you if you agree with the return it has prepared on your behalf. Generally, the substitute for return is mailed with what is referred to as a “30 Day Letter”, which will provide you with 30 days to agree or appeal the substitute for return. If you don’t respond to the 30 day letter, the IRS will issue a “Notice of Deficiency” which will afford you a 90 day period to file a petition with the United States Tax Court to contest the proposed liability. If you file a petition with the Tax Court, the IRS is prohibited from making the assessment against you until after a decision has been entered by the Tax Court. However, if you fail to respond to the Notice of Deficiency, the IRS will make the assessment based on the substitute for return and will then proceed with collection.

Finally, many people do not realize that there are provisions in the Internal Revenue Code that allow for criminal charges to be brought in certain circumstances where an individual repeatedly fails to file timely income tax returns. Our detailed discussion of the potential criminal ramifications of failing to file income tax returns is beyond the scope of this article. However, if you have several unfiled income tax returns, you should consult a tax professional to discuss both the civil and potentially criminal ramifications of your failure to file and to develop a strategy to bring you back into compliance. If you have not filed because you are unable to pay your tax liability, you should know that so long as the matter stays civil, there are collection alternatives, such as an installment payment agreement or offer in compromise, to deal with the outstanding liability. However, if you continue to not file tax returns and the case becomes a criminal matter, not only are collection alternatives limited, but the mater will be far more costly in terms of legal fees, criminal and civil penalties, and the potential loss of freedom.

If you have unfiled tax returns, the burden likely weighs heavily on your mind. The non-filing may also have affected your ability to obtain credit, take a better job or receive certain benefits. You do not need to continue living underground or with the fear of what will happen when the IRS finds you. Obtain the services of a tax professional who can help you prepare your outstanding returns and file those returns with the IRS. Keep in mind that there are always ways to deal with a collection matter and the key is to just take one step at a time.