Tax Controversy & Resolution: Unfiled Tax Returns

Unfiled Tax Returns

In general, the IRS maintains a file going back numerous years of all W2′s, 1099′s and 1098′s (mortgage interest paid) filed in the name of individual taxpayers. AndreTaxCo can determine certain facts from Master File Transcripts, available for those years where the IRS has prepared a Substitute Return.

IRC § 6103 provides circumstances when IRS may disclose information. Tax return info may generally be disclosed to the taxpayer or their representative authorized through applicable filings (e.g. Form 2848, Power of Attorney and Declaration of Representative) as further discussed below.

Why You Should File Your Past Due Return Now
  • Avoid Interest and Penalties

    • File your past due return and pay now to limit interest charges and late payment penalties.

  • Claim a Refund

    • You risk losing your refund if you don't file your return. If you are due a refund for withholding or estimated taxes, you must file your return to claim it within 3 years of the return due date. The same rule applies to a right to claim tax credits such as the Earned Income Credit.

    • The IRS holds income tax refunds in cases where its records show that one or more income tax returns are past due. The IRS generally holds them until receiving the past due return or receive an acceptable reason for not filing a past due return.

  • Protect Social Security Benefits

    • If you are self-employed and do not file your federal income tax return, any self-employment income you earned will not be reported to the Social Security Administration and you will not receive credits toward Social Security retirement or disability benefits.

  • Avoid Issues Obtaining Loans

    • Loan approvals may be delayed if you don't file your return. Copies of filed tax returns must be submitted to financial institutions, mortgage lenders/brokers, etc., whenever you want to buy or refinance a home, get a loan for a business, or apply for federal aid for higher education.

  • If You Owe More Than You Can Pay

    • If you cannot pay what you owe, you can request an additional 60-120 days to pay your account in full through the Online Payment Agreement application or by contacting the IRS directly. If you need more time to pay, you can request an installment agreement or you may qualify for an offer-in-compromise.

Common Penalties, Assessments, & Accruing Interest for Failure to File / Pay Taxes

Failure to File Penalty

The Internal Revenue Code (IRC) imposes a delinquency penalty for failure to timely file a tax return. IRC § 6651(a)(1). The penalty is equal to 5% of the net amount of tax due on the return for each month the return is delinquent, up to a maximum of 25%.

 

A minimum penalty equal to the lesser of

  • $205 (effective for returns required to be filed before January 1, 2020) or  $435 (effective for returns required to be filed after December 31, 2019); or

  • or 100% of the tax required to be shown on the return will be imposed if the return is not filed within 60 days of the due date, unless it is shown that such failure is due to reasonable cause and not due to willful neglect. See IRC § 6651; Treas. Reg. § 301.6651-1(c)(1).  

 

Fraudulent Failure to File Return Penalty

If the IRS determines that a failure to file was due to fraud, the failure to file penalty is increased from 5% per month to 15% per month, up to a maximum of 75% of the tax due. IRC § 6651(f). The IRS has the burden of proving the fraud element of the increased portion of the penalty by clear and convincing evidence. 

Failure to Pay Tax Penalty

IRC § 6651(a)(2) also imposes a delinquency penalty for failure to pay tax shown to be due on a return equal to ½ of 1% of the tax per month, up to a maximum of 25%. For any month in which the failure to file and failure to pay penalties both apply, the amount of the failure to pay penalty reduces the amount of the failure to file penalty.

Because the failure to pay tax penalty is based upon the amount of tax shown to be due on the return but not paid, the penalty cannot be imposed if no return is filed or if the IRS prepares a substitute return. Rev. Rul. 76-562, 1976-2 C.B. 430.

The Internal Revenue Code also imposes a delinquency penalty for failure to pay tax on tax required to be shown on a return (deficiency/after audit) which is not paid within 21 days after notice and demand for payment (10 days if the amount is $100,000 or more). IRC § 6651(A)(3). The penalty is reduced to 1/4 percent per month when an installment agreement is in effect.

 

As with the failure to file penalty, the failure to pay tax penalty may be excused by establishing reasonable cause. The taxpayer must demonstrate that despite the exercise of ordinary business care and prudence he was nevertheless unable to pay the tax when due or would have suffered an undue hardship if the tax was paid on the due date. Treas. Reg. § 301.6651-1(c)(1).

 

Undue hardship is something more than inconvenience to the taxpayer. Undue hardship exists, for example, if payment of the tax when due would have resulted in a substantial financial loss, such as the sale of property at a sacrifice price. Treas. Reg. §§ 6651-1(c)(1), 1.6161-1(b). The procedure for obtaining relief from the failure to pay tax penalty is identical to that for obtaining relief from the failure to file penalty.

 

Estimated Tax Penalty

If the taxpayer has not made sufficient prepayments of his tax liability, the IRS may assert a penalty for failure to make estimated tax payments. IRC § 6654.

 

The penalty is computed in accordance with a formula that takes into account the amount and timing of estimated tax payments that were required to have been made. IRC § 6654(d). There is no reasonable cause exception to the imposition of the estimated tax penalty. However, the IRS may waive the penalty under certain circumstances if it is determined that by reason of casualty, disaster, or other unusual circumstances imposition of the penalty would be against equity and good conscience. IRC § 6654(e)(3)(A). 

 

Failure to Timely Deposit Penalty

IRC § 6656 imposes a time sensitive failure to deposit penalty. The penalty ranges from 2% to 10% based on days elapsed after the due date. A 15% penalty rate may apply if payment is not made subsequent to notice and demand.

Accuracy-Related Penalty

IRC § 6662 provides a penalty equal to 20% of the portion of the underpayment attributable to negligence or disregard of rules or regulations, or a substantial understatement of tax. IRC § 6662(a).

 

The accuracy-related penalty only applies where a return is filed with the IRS. Accordingly, the penalty does not apply when the IRS prepares substitute returns.

 

In general, the accuracy-related penalty can be avoided upon a showing of reasonable cause. IRC § 6664(c)(1). The substantial understatement prong of the penalty can also be avoided if there is substantial authority for the taxpayer's position or adequate disclosure.

 

The IRS may impose the accuracy-related penalty in addition to the failure to file penalty, but may not consider the fact that the return was filed late in determining whether to impose the accuracy-related penalty. Treas. Reg. § 1.6662-2(a). 

 

The accuracy-related penalty is also imposed for substantial errors in valuing property on income, estate and gift tax returns, and overstatements of pension liabilities. Valuation errors are subject to a two-tier penalty rate structure of 20% and 40%. Valuation misstatements must meet certain threshold levels before the penalties apply. Misstatements related to Code § 482 transactions may also be subject to overstatement penalties.

 

Fraud Penalty

In general, the civil fraud penalty is equal to 75% of the underpayment attributable to fraud. Former IRC § 6553(b)(1); IRC 6663(a). The term "fraud" means an "intentional wrongdoing on the part of the taxpayer motivated by a specific intent to evade a tax known or believed to be owing." Stolzfus v. United States, 398 F.2d 1002, 1004 (3rd Cir. 1968), cert. denied, 393 U.S. 1020 (1969). The IRS must establish fraud by clear and convincing evidence.

 

In general, it is presumed that the entire underpayment is attributable to fraud unless the taxpayer can establish otherwise by a preponderance of the evidence. IRC § 6663(b). Also, the IRS cannot generally impose the civil fraud penalty unless a return has been filed. IRC § 6664(b). However, the fraudulent failure to file penalty may be imposed if no return is filed. IRC § 6651(f).

 

Interest

The taxpayer's liability will be increased not only as a result of penalties, but also from the accrual of interest. Interest is required to be paid on any tax underpayment at a rate established on a quarterly basis under the Internal Revenue Code. IRC § 6601.

  • Interest is compounded daily. IRC § 6621.

  • Interest is computed not only on the amount of the underpayment of tax but also on penalties. As a general rule, interest on penalties begins to accrue if the taxpayer fails to pay within ten days after notice and demand for payment is made. IRC § 6601(e)(2)(A).

  • However, interest accrues on certain penalties such as the failure to file, fraud and accuracy-related penalties from the due date of the return. IRC § 6601(e)(2)(B)

 

Taxpayers are rarely successful in obtaining an abatement of interest. However, where the accrual of interest results from an error or delay on the part of an IRS employee to perform a ministerial or managerial act, interest may be abated. IRC § 6404(e)(1).

What If You Don’t File Voluntarily

Substitute Return 

If you fail to file, the IRS may file a substitute return for you. This return might not give you credit for deductions and exemptions you may be entitled to receive. The IRS will generally send you a Notice of Deficiency CP3219N (90-day letter) proposing a tax assessment. You will have 90 days to file your past due tax return or file a petition in Tax Court. If you do neither, the IRS will proceed with its proposed assessment. If you have received notice CP3219N you can not request an extension to file. 

If any of the income listed is incorrect, you may do the following:

  • Contact the IRS of the income error and provide supporting documentation and attach the corrected forms when sending your completed tax returns.

  • Contact the payer (source) of the income to request a corrected Form W-2 or 1099 to then submit to the IRS.

If the IRS files a substitute return, it is still in your best interest to file your own tax return to take advantage of any exemptions, credits and deductions you are entitled to receive. The IRS will generally adjust your account to reflect the correct figures.

Collection and Enforcement Actions

The return the IRS prepares for you (our proposed assessment) will generally lead to a tax bill, which, if unpaid, will trigger the collection process. This can include such actions as a levy on your wages or bank account or the filing of a notice of federal tax lien. If you repeatedly do not file, you could be subject to additional enforcement measures, such as additional penalties and/or criminal prosecution.

Notices for Past Due Tax Returns

You may receive one or more of the below notices if you have not filed your tax return. If the IRS files a substitute return, it is still in your best interest to file your own return to take advantage of all the exemptions, credits and deductions to which you are entitled. The IRS will generally adjust your account to reflect the correct figures.

Understanding Your IRS Notice Examples

  • CP59 Notice. The IRS sent you this notice because the IRS has no record that you filed your prior personal tax return or returns.

  • CP63 Notice. The IRS are holding your refund because you have not filed one or more tax returns and the IRS believes you will owe tax. 

  • CP259 Notice. The IRS records show that you are required to file a tax return for the tax periods indicated on your notice but haven’t.

  • CP515I Notice. This reminder notice tells you the IRS still have no record that you filed your prior tax return or returns. 

  • CP516 Notice. This notice reminds you that the IRS still has no record that you filed your prior tax return or returns. 

  • CP518I Notice. This is a final reminder notice that the IRS still has no record that you filed your prior tax return(s).

  • CP518B Notice. This is a final reminder notice that the IRS still has no record that you filed your prior tax returns.

  • CP2566 Notice. The IRS didn't receive your tax return. The IRS has calculated your tax, penalty and interest based on wages and other income reported to the IRS by employers, financial institutions and others.

  • CP2566R Notice. The IRS previously sent you a CP63 notice informing you the IRS is holding your refund until the IRS receives one or more unfiled tax returns. Because the IRS received no reply to its previous notice, the IRS calculated your tax, penalty and interest based on wages and other income reported to the IRS by employers, financial institutions and others.

  • CP3219A Notice. The IRS received information that is different from what you reported on your tax return. This may result in an increase or decrease in your tax. The notice explains how the amount was calculated and how you can challenge it in U.S Tax Court.

  • LT3219B Notice. This Statutory Notice of Deficiency notifies you of IRS intent to assess a tax deficiency and of your right to petition the U.S. Tax Court to dispute the proposed adjustments. The IRS made these adjustments because the IRS received information from third parties that doesn’t match the information you reported on your return.

  • CP3219N Notice. The IRS didn't receive your tax return. As such, the IRS has calculated your tax, penalty and interest based on wages and other income reported to us by employers, financial institutions and others.

Tax Returns & Transcript Requests:

Effective January 2019, transcripts will no longer be faxed by the IRS to taxpayers or reps. Beginning May 2019, IRS will stop mailing transcripts to those listed on Live 5 e of Form 4506-T or T-EZ. All such requests will be mailed to taxpayer’s address of record.

About Form 4506, Request for Copy of Tax Return

Use Form 4506 to:

  • Request a copy of your tax return, or

  • Designate a third party to receive the tax return.

  • Form 4506

About Form 4506-T, Request for Transcript of Tax Return

Individuals file this form to:

  • Request a tax return transcript for the current and the prior three years that includes most lines of the original tax return.

  • Designate a third party to receive a transcript.

  • There is a new transcript format that better protects taxpayer data. This new format partially masks personally identifiable information. Financial data will remain fully visible to allow for tax preparation, tax representation or income verification. Because the full SSN is masked, the IRS has created an entry for a Customer File Number. A 10-digit Customer File Number is selected by the requester and entered on a new Line 5b of Form 4506-T and 4506T-EZ.

Individual Returns: Ways to Get Transcripts

You may register to use Get Transcript Online to view, print, or download all transcript types listed below. 

If you're unable to register or you prefer not to use Get Transcript Online, you may order a tax return transcript and/or a tax account transcript using Get Transcript by Mail. In general, it takes 5 to 10 calendar days for delivery.

You may also request any transcript type listed below by faxing/mailing Form 4506-T, Request for Transcript of Tax Return as instructed on the form.

Transcript Types

The IRS offers the following transcript types at no charge to you: 

  • Tax Return Transcript - shows most line items including your adjusted gross income (AGI) from your original tax return (Form 1040, 1040A or 1040EZ) as filed, along with any forms and schedules.

    • It doesn’t show changes made after you filed your original return. This transcript is only available for the current tax year and returns processed during the prior three years.

    • A tax return transcript usually meets the needs of lending institutions offering mortgages and student loans. 

    • Note: the secondary spouse on a joint return must use Get Transcript Online or Form 4506-T to request this transcript type. When using Get Transcript by Mail or phone, the primary taxpayer on the return must make the request.  

  • Tax Account Transcript - shows basic data such as return type, marital status, adjusted gross income, taxable income and all payment types. It also shows changes made after you filed your original return.

    • This transcript is available for the current tax year and up to 10 prior years using Get Transcript Online or Form 4506-T.

    • When using Get Transcript by Mail or phone, you’re limited to the current tax year and returns processed during the prior three years. 

    • Note: If you made estimated tax payments and/or applied an overpayment from a prior year return, you can request this transcript type a few weeks after the beginning of the calendar year to confirm your payments prior to filing your tax return.

  • Record of Account Transcript - combines the tax return and tax account transcripts above into one complete transcript. This transcript is available for the current tax year and returns processed during the prior three years using Get Transcript Online or Form 4506-T.

  • Wage and Income Transcript - shows data from information returns we receive such as Forms W-2, 1099, 1098 and Form 5498, IRA Contribution Information. Current tax year information may not be complete until July. This transcript is available for up to 10 prior years using Get Transcript Online or Form 4506-T.

  • Verification of Non-filing Letter - provides proof that the IRS has no record of a filed Form 1040, 1040A or 1040EZ for the year you requested. It doesn't indicate whether you were required to file a return for that year. This letter is available after June 15 for the current tax year or anytime for the prior three tax years using Get Transcript Online or Form 4506-T. You must use Form 4506-T if you need a letter for tax years older than the prior three years.

 

Note: A transcript can show return and/or account data. It also can show changes or transactions made after you filed your original return. Transaction codes consist of three digits. They are used to identify a transaction being processed and to maintain a history of actions posted to a taxpayer’s account. For further information regarding transaction codes, please see Document 11734 - Transaction Code Pocket Guide.

Note: A transcript isn’t a photocopy of your return. If you need a copy of your original return, complete and mail Form 4506, Request for Copy of Tax Return, along with the applicable fee.

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