IRS Failure to File Compliance:
Most non-filing investigations/examinations of taxpayers are initiated by the IRS based upon computer matches. The IRS uses both “non- filer” and “late filer” programs. Utilized by the IRS are Forms W-2 and Schedules K-1 and numerous types of Form 1099 which reflect reportable taxable income but no tax return filing. A newer IRS program uses business credit card transaction reports (Form 1099-K) to identify non-filers as well as suspicious underreporting. Form 1099-K as other requested reporting forms are also utilized by the IRS in regular examinations of filed returns.
Normally the IRS will initiate a non-filing letter 15 months after a Form 1040 (individual Income Tax Return) is due. In the case of business taxes and payroll taxes, such as Form 941 employment tax returns, IRS delinquency notices begin 8 weeks after the due date of a return.
The IRS will attempt to secure taxpayer returns by sending Service Center notices requesting that returns be filed. If the taxpayer fails to file despite the Service Center notices, the IRS may follow up in several different ways. It may prepare “substitute” tax returns and tax assessments (IRC §6020(b)) for the taxpayer based upon information documents received from third parties. These IRS filed reports are referred to as “wage and payor” information.
The Internal Revenue Service delinquency check will normally result in the IRS issuing four (4) computer notices regarding unfiled Forms 1040 over a six (6) month period. In the case of business taxes, such as Form 941 for employment taxes, the Internal Revenue Service will normally issue three (3) notices spaced over a period of 22 weeks. IRS collection representatives become involved after the Form 941 notice cycle is completed – action at either an IRS Service Center or, more likely, by assignment to a field Revenue Officer. The notice cycle on unfiled Forms 1040 can be one year, or in some cases, several years before taxpayer contact.
Failing to file returns is a criminal misdemeanor under federal statute (IRC §7203). In some instances, repeated failures to file can be prosecuted as a criminal felony (IRC §7201). Certain individuals are more likely to be prosecuted by the IRS than others. The complete guidelines regarding criminal non-filing are contained in the Internal Revenue Manual. Here is a partial list of non-filers of interest to the IRS Criminal Investigation Division:
- The non-filing involves illegal drug income or known organized crime figures and persons alleged to be receiving graft or income from illegal sources.
- The taxpayer’s occupation and education denote prima facia evidence of knowledge concerning his/her filing obligations. Examples include public officials, attorneys, accountants and financial planners.
- The non-filer is a tax protester.
- Making false statements to the IRS in response to IRS correspondence or at an IRS examination.
Failure to File Strategies:
For numerous reasons, many taxpayers fail to file returns – mostly procrastination and those who do not have the cash flow to pay the tax liability. Small and median sized new businesses often, in a cash crunch, pay other creditors in preference to the IRS – the IRS call/letter is months away; other taxpayer creditors can be making payment demands immediately. Any delay is a bad idea because of numerous IRS penalties.
For most taxpayers, the act of non-filing is a civil creditor/debtor issue. Few criminal cases are initiated on straight forward non-filed returns. The IRS, however, is an extremely aggressive creditor with broad ranging statutory powers to collect tax deficiencies. Unlike regular civil cases and ordinary law suits, the IRS need not reduce the tax debt to a civil judgment in a court of law; rather the IRS need only rely on facts that a tax deficiency has been assessed (including substitute return computation turned into assessments), the taxpayer has been properly noticed of the tax deficiency and the IRS has issued “Notice of Intent to Levy” (registered letter 1058). Once these prerequisites are met by the IRS, as required by federal statute, the IRS may seize and levy upon taxpayer’s property even when the taxpayer has not filed a return. The information in this paragraph presumes the IRS has created a substitute tax return assessment for the non-filer through internal records. Unpaid but filed returns go through the same notice sequence to establish levy authority.
The non-filer client and the failure to pay client are the most common IRS collection/controversy problems encountered by tax controversy practitioners. If the tax practitioner is an accountant, the accountant must determine whether the taxpayer has criminal exposure for failure to file returns which is a misdemeanor, or for tax evasion which is a felony. In some cases it may be advisable to refer the client to an attorney in order to protect the client from inappropriate disclosures under attorney-client privilege protection.
Many clients come to tax practitioners at the last possible moment, usually under aggravated and advanced circumstances. Their wages have been garnished or the IRS has levied their bank account. Alternatively, taxpayers have been denied credit on a loan request because of IRS filed tax liens. The wage levy in particular can have disastrous effects on the employer/taxpayer employee relationship and taxpayer cash flow. A wage garnishment is a “continuing levy” and will not be removed until the taxpayer takes affirmative action in dealing with the IRS. Filing delinquent returns is usually a prerequisite to obtaining release of an IRS levy.
Delinquent returns must be prepared and filed. Unfiled tax returns do not have a collection statute of limitations.
Clients are frequently confronted with the following question: “Should I file the return right now, or wait until I have the money to pay for it?” The answer is straight forward. The return or returns should be filed as soon as possible. If the client has any funds available for payment, a check should be enclosed with the return. The reason is that non-filing taxpayers are facing one of the highest penalty rates which the IRS is allowed to impose. The failure to file penalty rate is 5% pre delinquent month up to a maximum penalty of 25% of the tax due but unpaid by the due date of the return. There is also a failure to pay penalty added. Filing a timely return without payment only results in a late payment penalty (failure to pay penalty), which ranges from .05% to 1% per month. In all cases the IRS will also add interest at the statutory rates.
Filing a voluntary timely return without full payment will result in a lower tax/penalty assessments than non-filing or late filing. The IRS is generally favorable to entering into an installment agreement arrangement to pay back taxes on late filed returns which have not been full paid. Installment agreements are discussed elsewhere on this website