Non-Filer Assistance / Delinquent Returns

How important am I to the Federal and State Governments as a non-filer?

Times are tough and the state and federal governments need money. The IRS in particular has been hiring experienced Tax Attorneys, CPAs and Enrolled Agents to step up enforcement action. In the IRS’s opinion the non-filer creates one of the most significant compliance issues facing the U.S. system of taxation and accordingly has targeted the problem of non-filers as one of the IRS’s highest priorities. The IRS estimates that approximately 10 million taxpayers fail to file their federal income tax returns each year.

The IRS posts on its website “one of the basic tenets of our tax system is the belief that all citizens must comply with the requirements to file returns and pay taxes. Taxpayers who willfully fail to file income tax returns pose a serious threat to tax administration and voluntary compliance”.

In response to the non-filer problem the IRS has implemented a cross-functional National Non-Filer Strategy. The overall goal of this strategy is to bring non-filers back into compliance. The IRS has involved its Criminal Investigation (CI) division, which consist of agents trained in law enforcement and armed with side arms, in this program where high profile non-filers are nonresponsive to outreach efforts. IRS-CI has devoted resources to identify these individuals, and in the most flagrant cases, criminal prosecution has been and will continue to be recommended.

The IRS- CI mission statement is as follows:

Criminal Investigation serves the American public by investigating potential criminal violations of the Internal Revenue Code and related financial crimes in a manner that fosters confidence in the tax system and compliance with the law.

How likely is it that I will face criminal prosecution and go to jail when I file my delinquent tax returns?

Owing taxes is not a crime. However, it is a crime to fail to file tax returns as they become due. While no absolute assurance can be given to a taxpayer that criminal prosecution is not even the remotest possibility, experience shows that unless certain narrowly defined criteria for prosecution are met, criminally prosecution is highly unlikely.
The following criteria increase a non-filers exposure to criminal prosecution:

Tax protestors who are unrepentant and habitually refuse to file their tax returns in the face of contrary facts, case law, and primary authority provided by the taxing authorities.
Those who are combative and completely refuse to cooperate with the IRS.
High profile persons who are known in their respective communities are at increased risk because the taxing authorities may wish to make an example of them so as to scare others in the non-filer’s community into compliance.

On the bright side, even where the above criteria are met, the IRS Agents enforcing tax criminal laws are often rather selective, tending to pursue only the most egregious cases. However, to keep the public guessing, on occasion even average citizens who are not widely known in their respective communities, who are delinquent as to relatively small amounts are occasionally criminally prosecuted.

While willful failure to file, is punishable by up to one year in prison for each tax year. I have never had a client, or have heard of a client in my 15 years of experience to be prosecuted or even to be threatened with it. Remember that it costs money to prosecute and incarcerate a non-filer, and while a non-filer is sent to jail, his or her family is likely to wind up on the welfare roles.

What should I do to re-enter the Tax System?

IRS policy encourages non-filers to make a voluntarily disclosure by filing the delinquent returns, and thus bring themselves current on any outstanding filings and voluntarily report the associated income tax, penalties and interest due.

The IRS’s official written policy is that where non-filers voluntarily come forward, before an IRS investigation or examination has begun, have only legal source income, file an accurate tax return and pay (or make arrangements to pay) their tax, they will not be referred for criminal prosecution for failure to file.

What specifically can the Tax Law Office of David W. Klasing do to help me re-enter the system?

The Tax Law Office of David W. Klasing will take the following reasonable and necessary actions to attempt to delay or halt government enforcement action while you have time to gather the information that will enable us to prepare the missing returns:

Shield you from criminal prosecution
Shield your wages, bank accounts and business assets from liens and eventual levy
- (Note: A lien is a public claim by the government to a specific asset they attach it to. A levy is the actual action of the government taking your asset – I.E. requiring your bank, customer or employer to remit your funds directly to the government.)
Shield your business from the following government actions, which could cause its premature demise.
- Seizure of business assets
- Seizure of working capital
- Physical lock out of employees and customers
- Negative publicity and affect on credit rating from liens and levies
Respond to or help in avoiding tax audits and further notices
Negotiate penalty abatements or reductions for tax and penalty assessments where reasonable cause can be established
Negotiate 5 year repayment plans for any balances ultimately owed
Obtain our clients a valuable commodity – a little more time before the government takes a harmful action
Help clients to get on with the rest of their lives, sleep better at night, and reduce or eliminate anxiety over the federal or state government detection, prosecution and collection

Should I use an Attorney, EA or a CPA to represent me when I re-enter the tax system?

No other type of tax professional offers the level of “Client privilege” that is legally required of an attorney. Only an attorney has “Attorney-Client privilege” with his clients. The attorney’s confidentiality requirements are vastly more comprehensive than the “confidentiality privilege” required of, or optional to, other types of tax representatives. Unlike with an attorney, a great deal of what you disclose to another type of tax professional can be forced to be revealed in a court of law or administrative proceeding where information or testimony is subpoenaed by the taxing authorities.

Moreover, any available privilege or confidentiality rules involving discussions between a client and another type of tax professional do not apply to criminal cases. Only the Attorney-Client privilege survives a state or federal criminal tax investigation or prosecution. The Attorney-Client privilege is a critical advantage where an attorney is representing and defending a non-filer who is unfortunate enough to be brought up on criminal charges.

What if I have a trusted relationship with a tax preparer and wish to have the additional protection of having a Tax Attorney represent me when I re-enter the tax system?

The non-filer would be wise to withhold any information from the trusted tax preparer initially because of the threat of criminal prosecution and the preparer’s lack of privilege. An attorney should be engaged prior to approaching the tax professional.

The Tax Attorney, trusted tax professional, and the client should first enter into a three-party agreement wherein the tax attorney retains the trusted tax professional to prepare the delinquent returns. In this manner information the trusted tax professional learns in the preparation of the returns, which is not disclosed on the returns themselves, will fall under the Attorney/Client privilege and thus can be protected from subsequent disclosure by the trusted tax professional.

What are the common reasons people drop out of the tax system?

People drop out of the system for a variety of reasons including: procrastination, the inability to pay, divorce, business failure, job layoff, illness, not understanding their filing requirement and some willfully fail to file in an attempt to evade their responsibility to report their income and pay their tax liability. The reason becomes truly relevant where there is a subsequent attempt to abate penalties or where an offer in compromise is subsequently filed.

How does the IRS identify non-filers?

New programs to identify and force compliance by non-filers are constantly being tested and implemented. The IRS has created a joint task force of revenue agents and tax auditors from the IRS Examination Division, revenue officers from the Collection Division, and special agents from the Criminal Investigation Division to locate non-filers and secure compliance with filing requirements.

The IRS has computer programs that constantly search for non-filers. These programs determine if a taxpayer has stopped filing returns or have never filed returns by matching up information obtained from third parties against IRS records (i.e. 1099’s and W-2s). The IRS’s computer capabilities are constantly being improved to enable the agency to match third-party income and expense information returns with taxpayers.

What happens after a non-filer has been identified by the IRS?

Once a non-filer has been identified, a series of computer-generated notices are mailed to the taxpayer at their last known address. Where no response is received on the notices the case is assigned to the Collection Division of the IRS. The Automated Collection System (ACS) within the Collection Division may eventually attempt to contact a taxpayer by telephone seeking the delinquent returns. If ACS is unable to secure the delinquent returns, a Revenue Officer may be assigned to contact the taxpayer in person at their home or place of business. The Revenue Officer has the option of determining if fraud has been committed by the taxpayer, in which case a referral may be made to CID for possible prosecution.

Once enforcement action has begun by the IRS, can I expect to hear from the State of California on the same issue (and visa versa)?

The IRS and California Franchise Tax Board share information and once enforcement action has begun by one of these organizations you can reasonably expect to hear from the other in the near future.

What is the government likely to do to force me to file the returns I have not filed?

The IRS uses a variety of methods to force compliance. ACS employees may contact neighbors, employers and others in an attempt to secure information about the taxpayer’s potential tax liability.

The IRS will eventually create tax returns from all information available to them under the Automated Substitute for Return Program (ASFR). The SFR Program and its automated version (ASFR) were developed to deal with taxpayers who have not filed tax returns voluntarily and for whom income information is available to substantiate a significant income tax liability.

Internal Revenue Code Section (IRC) 6212 authorizes the Service to send a notice of Deficiency when a taxpayer appears to have a filing requirement but does not comply by voluntarily filing a tax return. Thus the substitute return that they create is followed by two letters that are issued to the taxpayer at their last known address, a 30-day letter and a 90-day letter. These letters request the taxpayer file a return or explain why they are not required to file. The letters include a list of income information reported to the Service and the proposed tax assessment, which shows how the Service will assess tax if no return is secured. If a return is not received by the end of the 90-day period, the account defaults and an assessment is made. An income tax deficiency is assessed if the taxpayer does not file a petition to Tax Court. The government will then attempt to seize the non-filer’s wages, bank accounts and business assets in satisfaction of the deficiency assessed on the substitute return.

These Substitute For Returns (SFR) often lack the information a taxpayer would have included on a filed return. For example, the IRS will take the sum of the 1099’s received on a self-employed non-filer and subject the total of the 1099’s to income and self-employment tax. Since no deductions are provided by the taxpayer and are not known to the IRS, the resulting tax liability and associated penalties and interest are quite often grossly overstated.

Additionally, SFR’s are often overstated because the non-filer is only credited with their own personal exemption even where they are married and have children, moreover non-filers are not allowed itemized deductions like mortgage interest, state or property taxes, charitable contributions or health care expenses.

Can a deficiency on a substitute return be modified by a subsequent delinquent return?

While the IRS is not statutorily forced to accept a return which you file after an SFR has been created and assessed upon, the IRS routinely will accept a subsequent return submitted by the non-filer. Once the IRS accepts the subsequent return, the tax penalties and interest previously assessed are reduced to what is calculated on the subsequent return rather than on the previous SFR.

Can a deficiency on a substitute return be discharged in a subsequent bankruptcy?

Since a return was never filed by the taxpayer the amounts due on the SFR’s usually cannot be discharged in a subsequent bankruptcy.

What happens where the IRS have not previously filed substitute returns?

All that is necessary is to file the delinquent returns. If information to file (Original W-2s, 1099s etc.) is unavailable, the information can be gleaned from transcripts obtained from the IRS. The IRS usually is able to provide information for at least the last seven or eight years.

What penalties are the IRS able to impose on the delinquent tax filings?

Non-filing has a price and thus when you are eventually forced into compliance, interest and penalties may easily double the debt that would have been owed if the return had been filed timely.
IRS collection agents are instructed not to waive penalties in non-filer cases without reasonable cause and the penalties that they are to consider assessing on secured delinquent returns under IRC Sec. 6020(a) are as follows:
Failure to File Penalty (IRC Sec. 6651(a)(1)).
Estimated Tax Penalty (IRC Sec. 6654 or IRC Sec. 6655).
Failure to Pay Penalty (IRC Sec. 6651(a)(2)).
Accuracy Penalty (IRC Sec. 6662(a)).
Fraudulent Failure to File (IRC Sec. 6651(f)).

Note: The burden of proof is on the Government to establish fraudulent failure to file and this penalty can only be asserted for years after 1988 where there is clear and convincing evidence that the failure to file was done fraudulently.

Am I likely to be audited by the taxing authorities once I file the delinquent prior year returns?

The preparation of delinquent tax returns requires a heightened level of care and accuracy because of the heightened risk of subsequent audit by the taxing authorities. The IRS realizes that many non-filers will not have pristine records from which income and deductions can be determined. A delinquent return that is deemed fraudulent upon subsequent examination by a taxing authority is serious business and will grossly compound a non-filers problems!
However, the stated IRS objective of their non-filer strategy is to bring non-filers back into the tax system by securing a substantially correct delinquent return. The focus of IRS non-filer examinations is the non-filer’s tax liability as a whole rather than the considerations of individual income and expense issues.

The IRS specifically instructs their agents to pay special attention to Large, Unusual or Questionable Items (LUQs) within delinquent returns. LUQ’s will be deemed appropriate if the non-filers responses resolve the examiners questions and are consistent with other available information, even if no records are inspected. In-depth review of the non-filers books and records should be limited to material items where the non-filers responses do not adequately resolve the issue.

The agents are also told to look for:

Indications that the non-filer had knowledge of filing requirements (i.e., professional with an advanced education, person who works directly in the tax field).
A large number of cash transactions (i.e., purchases by cash, cash deposits).
Indications of significant unreported income (i.e., substantial interest and dividends earned, investments in IRA accounts, stock and bond transactions, high mortgage interest paid).

Do I have to file every delinquent tax return for every missing tax year?

If you are approached by the IRS over delinquent returns their agents are trained to request that the non-filer file all delinquent returns without regard to the number of years or tax periods involved. On the other hand, IRS Policy Statement P-5-133 provides guidelines for the extent of retroactive enforcement in delinquency cases. Policy Statement P-5-133 provides that enforcement should not extend beyond six years, but there are instances where longer or shorter periods maybe enforced.

Factors agents are instructed to consider in determining whether shorter or longer periods should be enforced are:

Prior history of noncompliance
Existence of income from illegal sources
Publicity effect on the voluntary compliance of other taxpayers
Anticipated revenue in relation to the time and effort required to determine the tax due
Special circumstances existing in the case of a particular taxpayer and available information

Ordinarily, an IRS group manager’s approval is required for all enforcement activity that is less than or exceeds the six year period. However, a group manager’s approval is not needed if the non-filer voluntarily files returns beyond the established enforcement period of six years.

Prior years beyond the 6-year enforcement limit may still be required because of some pending IRS action. Those outstanding actions include balance due years or special monitoring activity. Lastly, when filing an Offer in Compromise after filing the delinquent returns, all of the delinquent tax returns are required to be filed in order to be eligible for an Offer in Compromise.

If I am due a refund or a credit on a delinquent tax year will I receive them?

A claim for refund/credit must be filed within three years from the time the tax return was filed or two years from the time the tax was paid, whichever of such periods expires later. If the claim is filed within three years of the time the return is filed, the amount of the refund/credit is limited to the tax paid within the three-year period (plus any period of extension of time to file the return) preceding the filing of the claim. This is often referred to as the “three-year look-back period.”

The non-filer should receive a certified notice of claim disallowance when a delinquent return is received by the IRS requesting a refund or credit, which is barred by the statute of limitations.

Will any subsequent collection action taken by the taxing authorities after filing my delinquent returns affect my personal or business credit rating?

Tax liens will appear on your credit reports and will negatively affect your credit until they are released. These liens may also complicate but not necessarily prevent, any subsequent sales of real estate liened by the taxing authorities.