Late Filing Returns

Jim Buttonow, CPA CITP

Updated on:

Each year, millions of taxpayers file late or don’t file at all. The IRS can identify, with Forms W-2 and 1099, that at least 7.5 million individual taxpayers do not file each year. Penalties apply if the taxpayer owes, or they have other required forms to be filed that carry a penalty for late filing. Processing late filed returns may require special handling, including passing through special IRS accuracy screening, addressing penalties, and handling enforcement.

Late Filing Facts

Long time non-filers may only need to file the last six years: this little-known IRS rule, called IRS Policy Statement 5-133, states that taxpayers need only file the past six years of returns. The IRS can deviate from this rule, but rarely do so. The IRS can deviate from the six-year filing rule when the taxpayer has a business or when Forms W-2/1099 on file with the IRS indicates that the taxpayer will owe a large amount of back taxes. Before a taxpayer files multiple back returns, it is always a good idea to interview the IRS to see how they are applying Policy Statement 5-133.

The penalty for late filing is steep, but only applies to individuals if you owe: the penalty for late filing is 5% per month, up to 25%. However, the Failure to File penalty only applies if you owe the IRS – not if you have a refund.

Non-filing can lead to criminal prosecution: non-filing is a serious noncompliance issue. Multiple year non-filers can lead to criminal prosecution if the IRS can prove that the taxpayer willfully and intentionally did not file a required return. The most common non-filer criminal profile is a multiple year non-filer who has a significant amount of back taxes owed. The IRS will look for indicators of fraud and, if found, will refer the taxpayer for criminal investigation and possible prosecution. Taxpayers can only look to the IRS’ most famous criminal case – Al Capone – as evidence of the seriousness of non-filing.

Watch out for hidden late filing penalties: some returns have required attached forms or schedules that carry their own late filing penalties. These penalties are assessed regardless of whether the client owes the IRS or not. For example, taxpayers who are officers, directors or shareholders in certain foreign corporations who late file Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations, face a $10,000 late filing penalty for each Form 5471 filed.

Really late returns go through special IRS screening: each November after the preceding tax year, the IRS starts identifying delinquent tax returns. The IRS initially asks for the taxpayer to voluntarily file (through sending a IRS Letter CP515). However, if the taxpayer does not file or respond to the IRS indicating that they do not have a filing requirement, the IRS can investigate (called a taxpayer delinquency investigation or “TDI”) on the taxpayer. The IRS can also proceed to file a return on behalf of the taxpayer (called a substitute for return or “SFR”) – with the taxpayer owing significant tax, penalties, and interest. If the IRS proceeds to a TDI or a SFR, the taxpayer will have to file with the investigating unit and pass a series of screening tests before the return is accepted.

The IRS can file a return for you – and the outcome is not good: this return is called a substitute for return or SFR. The taxpayer is not given any deductions, credits, or favorable filing status when the IRS files an individual SFR. The taxpayer also is assessed the failure to file and a failure to pay penalties. In the end of the SFR process, the taxpayer will owe (the IRS does not create refund SFRs) and the IRS begins to collect on the balance owed immediately.

When an IRS files a return for a taxpayer, they can replace it with a correct return: this process is called SFR reconsideration. A taxpayer will file a return with the IRS SFR unit and this unit will screen the return for accuracy. If the IRS accepts the return, the taxpayer’s account will be adjusted for the correct tax, penalties and interest. This process can take up to 6 months. It is important that the taxpayer get their account information and match it to the prepared return before it is filed. This will streamline the process and avoid additional scrutiny, including an audit, by the IRS.

After three years, you forfeit your refund: if you miss filing and more than three years pass (including extensions), any filed return will forfeit the refund.

Late Filing Solutions

Research Your Account and File

It is important for a taxpayer to get information about their account to file a late return. Specifically, taxpayers need to get their Forms W-2/1099 that are on file with the IRS, their withholding and estimated tax information, and their status with the IRS. This information will help the taxpayer effectively file an accurate return that gets accepted by the IRS.

Request Penalty Abatement for Late Filing

Late filers may owe the failure to file penalties if they owe when they file or if they file a related form or schedule that has late filing penalties. Some returns allow the taxpayer to request non-assertion of the penalty when the return is filed by paper (as opposed to electronically). However, most requests for failure to file penalty relief are requested after the penalty has been assessed.

The process of requesting relief after filing is called penalty abatement. There are two primary reasons for abating the failure to file penalty: reasonable cause and first-time abatement. It is essential that the taxpayer use the most advantageous process to request abatement. The options include a phone call, a written letter, a claim for refund, or an appeal using the several appeals avenues available.

Substitute for Return Reconsideration

If the IRS has filed a return for the taxpayer (called a substitute for return or “SFR”), then the IRS will process your return through its SFR compliance unit. This unit has special screening procedures to resolve. These procedures are referred to as an SFR reconsideration. A successful SFR reconsideration results in reduced tax, penalties, and interest.

Tax Delinquency Investigation Resolution

When a taxpayer files late, the IRS can start a delinquency investigation. It is important to file with the appropriate IRS compliance unit in these cases with a return that meets their screening protocols. This will close the investigation and allow the return to be accepted initially as filed. It will also help reduce the likelihood of a future audit. Resolving the delinquent return investigation might also require that the taxpayer executes a collection alternative on any unpaid balances.

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