Non-Filers Beware: The IRS May File Your Return for You

The IRS utilizes the Automated Substitute for Return (ASFR) program to assist in enforcing filing compliance for taxpayers who have not filed individual income tax returns and appear to owe a tax liability. Congress gives the IRS authority to prepare these returns under IRC Sec. 6020. Starting in the fall of 2015 through May 21, 2019, the IRS suspended this program, citing budget constraints.  There were 380,348 cases selected in fiscal year 2019, with just over 100 full-time equivalent employees assigned to the ASFR program, as noted by the taxpayer advocate service in its 2019 Annual Report to Congress. During the period the program was suspended, two of the three recommendations from the 2015 Annual Report to Congress were implemented which should save the IRS time/resources and lessen the taxpayer burden.  It is important to note that the substitute for return is not the ideal method to file your return.

The IRS is authorized to use third-party information, if a taxpayer with a filing requirement fails to file a tax return, to determine and assess a tax liability. A Substitute for Return (SFR) is prepared by the IRS based on informational reporting documents (such as Forms W-2 and 1099) filed by employers, financial institutions and other third parties.

The algorithm used by the ASFR program makes assumptions designed to maximize a taxpayer’s liability. An assumption is made that the taxpayer is single (or married filing separately in cases that there is evidence the taxpayer is married) and has no dependents and allows only the standard deduction, even where the IRS possesses third-party information that reflects allowable deductions that would exceed the standard deduction amount.   In failing to take into account the correct filing status, deductions and possible credits for dependents, the ASFR program often computes a greater tax liability then the taxpayer owes.

Once the IRS has prepared a substitute tax return, it notifies the taxpayer by mailing a Letter 2566 (assessment letter) to the last known address. The letter summarizes the sources of income that the IRS has used to propose the assessed tax. This letter provides the taxpayer with 30 days from the date of the letter to either send in a signed and completed tax return, send in a signed and dated Consent to Assessment and Collection form (agreeing to what the IRS has calculated) or send in a statement explaining why the taxpayer is not required to file a tax return.

If the taxpayer does not respond to the assessment letter within 30 days, the second letter, the Statutory Notice of Deficiency (Letter 3219-B), is sent by certified mail to the taxpayer. The IRS sends this mailing when it is prepared to assess the tax it has proposed and begins collecting the unpaid tax, interest and penalties. This letter provides the taxpayer with a second opportunity within 90 days from the date of the letter to take the three steps outlined in the original assessment Letter 2566.

While undergoing this process, taxpayers should consider that they risk losing a refund if they don’t file a return.  If a taxpayer is due a refund for withholding or estimated taxes, a return must be filed within three years of the return due date in order to claim it. As long as the taxpayer has not signed the Consent to Assessment and Collection form for the ASFR, the opportunity exists to prepare and file their own original return. In cases where the taxpayer has not maintained information to prepare their own return, wage and income reports are available from the IRS to assist. Return expense information would need to come from the taxpayer’s own records.

As noted, the IRS has implemented two of the three recommendations that the taxpayer advocate services proposed in the 2015 Annual Report to Congress. The recommendations adopted include taking into consideration

• third-party information that supports exemptions and deductions before selecting cases for the ASFR program, and
• the taxpayer’s prior filing history in the ASFR selection process model.

The IRS declined to accept the recommendation to update the abatement reason codes, which will make it more difficult for the IRS to determine which business rules are most responsible for the program’s inaccurate results. The taxpayer advocate service had only one recommendation in the 2019 Annual Report to Congress pertaining to the ASFR, which was to refine the ASFR abatement reason codes. Hopefully, the IRS will implement this suggestion soon to continue to help make the ASFR program more efficient.