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Are you required to Correct a Substitute for Return?

The taxpayer refuses to file a return. The IRS records of 1099s and W-2s show that the taxpayer probably owes taxes, so they file a return for the taxpayer. This is called a ‘Substitute for Return’ and it is a legitimate tax return for all legal purposes.

Eventually, as the pressure from the IRS grows, the taxpayer realizes that the easiest path in life is to get into compliance. They prepare the missing returns and discover that their calculations show a higher tax than the IRS’s assessment. Are they required to correct the IRS? If they fail to do so, are they open to a fraud charge?

The answer is NO! The IRS has made a legal assessment. If the lower amount is what the government wants to use, the taxpayer’s only legal requirement is to pay the tax assessed. You are only in trouble if you provide false information to the government. The fact that 3^rd parties did not report all of your income is not your problem.

Substitute for Return Basics

The IRS cannot assess a tax on you without a filed return. This puts them in a difficult spot. If the taxpayer does not file a return, what can they do to get a balance due on their books? The answer is the “Substitute for Return”. Basically, they file one for the taxpayer using the information on hand as to what the income was likely to be. This is where all those 1099s and W-2s come into play. Once the IRS computers have officially filed a Substitute for Return, tax due notices can start.

Here are a few things to understand about the Substitute for Return:

- The IRS is not out to minimize your taxes. They will file the return using single or married filing separate along with the standard deduction. No credits, no additional deductions.
- You can still file your return voluntarily and correct any errors in the tax accessed.
- You are not required to file any additional returns if say the IRS calculations of the tax were lower than your own calculations.
- The big disadvantage to not filing and letting the IRS do the work is that taxes due from an assessment from a Substitute for Return are never dischargeable in bankruptcy.
- Finally, the IRS only files a Substitute for Return when they think there are taxes due. Non-filers who have a refund due will eventually lose that claim once the 3 years have run out.

Haven’t filed forever! How many years to catch up?

The IRS currently has identified some 7 million potential non-filer cases. Getting caught up with them before they lower the ax is something that a lot of these people would like to do. But how do you go about that?

Do you have to go back to the beginning of time if you haven’t filed in decades? The answer is No. IRS Policy Statement 5-133 defines ‘Compliance’ as having the last 6 years of tax returns filed. File the last 6 years and the IRS will let you come in from the cold.

Compliance is an important issue for the IRS. They do not want to make a deal with someone who is compounding his or her tax problems. No payment plan, no Offer-in-Compromise, no relief from collection activities if your current returns are not being filed and your current year taxes are not being paid.

If you or someone you know has received a Notice of Intent to Levy or some other federal or state tax issue, please feel free to contact me at either (352) 317-5692 or email jim@taxrepgainesville.com.

Who is a fault for the IRS’s Incredible Incompetence?

Millions of calls from taxpayers to Taxpayer Service never get answered. After spending hours on hold, you might hear a click and then a dial tone. This is the IRS’s ‘curtesy hang-up’ because their computer has calculated they will not get to your call today.

Millions of IRS notices have gone out asking “Where is your 2020 Tax Return?”. Recently they admitted to more than 8 million unprocessed returns sitting in stacks somewhere. Their computers show nothing filed as a result, and the taxpayers are left with two bad options. One – ignore the notice on the assumption that sooner or later the IRS will get their return processed, or Two – send in another copy and further add to the backlog.

Who is responsible for this incredible mess? Interestingly enough – it’s not the IRS people. It’s Congress. I recently heard on a podcast by some very credible tax attorneys on just how the IRS budget works. Now bear in mind that the Federal Government spends a lot of time and money on hiring a competent Commissioner to oversee the IRS. However, that person has his or her hands tied behind their back from the get-go. The IRS does not get a lump sum authorization of money to run its operations. Instead, the budget is allocated to various functions. Some for answering phones, some for processing returns, some for audits, etc. If the demand for answers on the phones goes up, the commissioner cannot simply reassign auditors to help with the shift in demand. This is ludicrous. Why bother hiring high-end people to run the joint, if you are not going to give them the authorization to actually do the job?

The latest government budget bumps the IRS share by more than 12 billion dollars. Maybe it will help them get their act together with answering the phones and processing. I don’t think I will take that bet.

Innocent Spouse Claims are Hard to Win

The IRS will let an “Innocent Spouse” off the hook for unreported taxes created by their not-so-innocent spouse. To qualify the innocent spouse must prove that they:

had no actual knowledge of the understatement, or
had no reason to know of the understatement, and
they received no significant benefit from the under-reported taxes.

As you can guess, proving that you “had no reason to know” can be very subjective. Factors that the IRS will consider include:

Educational background and business experience.
The extent to which the spouse participated in the business.
Whether or not the spouse asked reasonable questions at the time the return was prepared.
Whether there was a departure from the trends of prior tax returns.

Showing that the innocent spouse received no significant benefit is also problematic. The IRS looks for evidence that the under-reported taxes were transferred to the innocent spouse in some manner. This could be cash or it could be payment of country club dues that were beyond the normal support needed for the spouse.

All these factors are hard to prove definitively, one way or the other. The result is that you need to plan on a trip to Appeals whenever you make this claim.

Are Crypto Currencies Safe from the IRS

I represent taxpayers in Gainesville and the state of Florida who has tax issues with the IRS.

IRS Levies

At this point in time, I don’t see how the IRS could levy a cryptocurrency account. The owner has the key codes. Absent these codes, it’s not likely the IRS could break the encryption. But there is a much bigger danger to crypto owners.

The Real Danger

That danger is JAIL TIME. Signing a tax return means you understand that the information is to the best of your knowledge under the penalty of perjury. The first question on the form 1040 for the last few years has been “did you receive, sell, exchange, or otherwise dispose of any financial interest in a virtual currency?” Answer no when you have one of these accounts makes it an easy referral for criminal prosecution when the IRS later determines that you do have such an account.

How it Works

The IRS successfully summoned the records of Coinbase for 2013-2015. The summons was upheld in court. Subsequently, the IRS has been negotiating with other virtual currency companies to gather more information about their users.

Here is the kicker to keep in mind. You sign a form 1040 in the current year and deny that you have any virtual currency. Three years later the IRS is finally able to crack the management of the company that provides you with access to your account. They feed the new data into their computers and then do a search for unreported transactions along with the negative answer on question number 1. Outcomes your name and the computer’s guess at the underreported tax. There is no statute of limitations on fraud. Worse, your defense attorney has next to nothing to work with other than some lame excuse about forgetfulness.

How Big a Risk?

Think this unlikely? The 2021 New England Tax Representation Conference included IRS statistics. Criminal referrals are up over 80% and most of that is related to the Coinbase summons. The idea that in the world of connected data servers that your information cannot be obtained by some government entity forever and ever is a pipe dream.

If you or someone you know has received a Notice of Intent to Levy or some other federal or state tax issue, please feel free to contact me at either (352) 317-5692 or email jim@taxrepgainesville.com.

Why the IRS will not accept an Offer to Compromise your Tax Debt

I represent taxpayers in Gainesville and the state of Florida who have tax issues with the IRS.

The IRS accepts less than a third of the Offer-in-Compromises that it receives. This is according to its own Data Book. Since it is a costly process to make an offer, it would behoove people to understand why these offers fail.

1. You must be in “Compliance” – meaning all the tax returns due for the last 6 years must have been filed and your current year estimated taxes and withholding are up to date. Failure here makes your offer Dead on Arrival. The IRS does not want to make deals with people who are digging the hole deeper.
2. The financial information that you provide must show that you have an inability to pay the debt in full. The IRS uses a formula approach to its evaluation. They apply it to the financial information you supply regarding the stuff that you own and your expected future cash flow. Making an offer that is less than what the formula shows that you can pay is almost certainly going to be rejected.

Why is it that the IRS will not accept an offer when the financial information shows a taxpayer could full pay? After all, the commercials all talk about them accepting “pennies on the dollar” when you use their services. The answer is simple – Why should they?

The IRS has collection powers that far exceed those of private debt collectors.

They have the police powers behind them and the force of law that will make a debtor’s life considerably more miserable than dealing with harassing phone calls from some debt collector agency.
They can levy wages, bank accounts, and money due to you from third parties. They can get into IRAs and pensions which are off-limits to everybody else.
Finally, they have an organization behind them that is not motivated by a profit percentage of the amount collected. They can be patient and persistent over the 10-year period that is the normal statute of limitations for collections.

Avoiding these two major pitfalls is why you probably need professional help from someone who understands the process and most importantly how the financial analysis works.

How often do “Innocent Spouse” Claims Work?

Joe and Sally file a joint income tax return. Unbeknownst to Sally, Joe has underreported his business income and now she is on the hook for the tax. The answer is to file an Innocent Spouse claim and sever the joint liability. Will it work?

The IRS accepts these claims less than 25% of the time. These claims usually get turned down because the innocent spouse, while not having direct knowledge, should have realized that the reported income was too low. Additionally, he or she benefited from the underpayment of the tax. If the country club dues were $30k and they live in a $500k house while sending their kids to a private school, the idea that the business only produces $50k of income should be obviously wrong to anybody.

The scenario that does get accepted are ones where one spouse not only underreports his or her income but keeps their lifestyle in line with the reported income. Let’s say Joe skims $200k from his business and then hides that money overseas. Sally would have no reason to suspect that the tax return was incorrect and she would have received no benefit from the tax evasion.

Interestingly, there is a situation that can improve Sally’s chance of winning this claim. Innocent Spouse claims require the IRS to notify the other spouse about the claim and the results. Many times, a non-innocent spouse will submit information to the IRS disputing the other spouse’s claim. Inevitably this spouse shows themselves to be such a dick that the innocent spouse claims have a better chance of being accepted because the IRS people develop sympathy for the innocent spouse.

What is “Innocent Spouse Relief”?

Innocent Spouse Relief is a claim requesting relief from the Joint and Several Liability that accompanies a joint tax return. There are three requirements for this claim to work:

There must be an understatement of the tax that can be attributed to erroneous items of the other spouse.
The innocent spouse did not know and had no reason to know about the erroneous items when he or she signed the return.
It would be inequitable to hold the innocent spouse liable because they did not receive any benefit from the understatement or they were abused.

If the Innocent Spouse Claim is upheld the tax liability is split up between the two parties, usually by calculating two married filing separately returns. The results then are used to allocate a portion of the joint liability to each.

The Innocent Spouse Claim is confused many times with the “Injured Spouse Claim” which is a whole different kettle of fish. An injured spouse is someone who filed joint and had their part of the refund allocated to their spouse’s debt in which they were not liable. Almost always this is the result of a marriage in which one spouse had previous debt.

The Innocent Spouse Claim should also not be confused with fraud. Forged signatures or returns signed under duress are not valid returns. These cases, particularly the ones with forged signatures, have a good chance of being referred for criminal prosecution.

Innocent Spouse Claims are filed using form 8857. The injured spouse must make the claim within 2 years from the start of “significant collection activities”. The date of a notice of intent to levy is the common starting date for filing these claims.

The IRS Statue of Limitations Date is Usually Wrong

The IRS has 10 years to collect on a tax debt. This time period starts on the date of assessment, that is the date they post it to their database. It would seem to be a simple manner to figure out when the 10 years is up, but this is taxes after all. The complexity comes from events that can put a hold on the statute days from running.

These holds are the result of events happening that prevent the IRS from taking collection actions such as seizing a tax debtor’s bank account. This is only fair since it is conceivable that people would take advantage of the IRS’s processes to constantly initiate requests for a payment plan with the sole intention of running the clock on the IRS.

What are the events that will prevent the IRS from taking collection actions?

Filing bankruptcy is a big one. The entire time that the bankruptcy estate is open plus the following 6 months is added to the Statute of Limitations date.
Requesting a payment plan is another. The number of days that the IRS is considering whether to accept or reject is added to the 10-year date. If they decide to reject, an additional 30 days is added.
Similarly, the days that an Offer-in-Compromise is under consideration places a hold Statute of Limitations from running.

Now we come to the problem.

The IRS is very poor in updating its database when an Offer-in-Compromise or Payment Plan request is either accepted or rejected. Instead of seeing statute of limitations dates calculated as maybe a 9-month extension, you find them to be years long. Whether this is by design or just typical bureaucracy inefficiency is hard to say with certainty. My guess is that they are aware that maybe half the dates are wrong, but this error works to their benefit and as result is not a high priority to fix.

Bottom line, if your strategy is to wait out the Statute of Limitations, you had better plan on doing some work to prove what that date should be.