You receive an IRS letter informing you they are proposing changes to your tax return. However, you never filed a tax return, so how can they correct it? The answer is that the IRS filed your return using Substitute for Return (SFR). An SFR is the IRS’s way of estimating your tax liability using the information they have on hand, such as W-2s, 1099s, and other income reports. While this might seem helpful, it most often results in a higher tax bill because the IRS doesn’t include deductions, credits, or exemptions you might be eligible for.
There are 3 possible outcomes from this process:
- The IRS is bang on right with its calculation of the tax.
- The IRS overstates the tax due.
- The IRS understates the tax due.
What should you do?
In the first case, they got it right. You do not need to do anything other than pay the assessment.
Usually, though, they overstate the tax due. The answer here is simple: File your actual and correct return (not an amended return).
But what should you do if the IRS understates the balance due? My recommendation is usually to do nothing. After all, you did not file a false return, and it’s on the IRS to audit and correct the assessment.
The Statute of Limitations
The 10-year Statute of Limitations for collecting the tax due runs as of the assessment date, regardless of whether it is an SFR. There is a small downside. Since you never filed your return, the 3-year Statute of Limitations for auditing and assessing additional taxes never runs. Given the IRS audit rates, this would seem like a small risk.
Conclusion
It’s better to file your return timely and avoid the IRS using its Substitute for Return process. Dealing with the inevitable letters can be irritating, and you risk additional interest and penalties. However, correcting the IRS assessment can be easily done by simply filing the correct return.
