An Overview of the IRS Tax Collections Process for Non-Tax Lawyers
4. Substitute for Returns (SFR)
The final way that balance dues are created is through what’s called substitute for return.
When you have a case of a non-filer, if the taxpayer doesn’t file a return for a year and the IRS will see a way to income information for that taxpayer or any number of other third party data sources, then the IRS will create a return for the taxpayer. That’s what is known as substitute for return or SFR.
If you’re calling the IRS and the IRS indicates the taxpayer has SFRs on file, that means the taxpayer didn’t file a return. Those SFRs can simply be corrected through a tax return and putting something on the IRS system with the SFR liability.
Generally, the statute for any changes through examination is three years with some exceptions. There’s exceptions for fraud which can extend the statue up for six. And there’s also an exception for SFRs. Any time a taxpayer does not file a return, the IRS can technically go back and file a return on their behalf.
In reality, the IRS is governed on SFRs to IRM 412.1.3. 412.1.3 says that as general policy consideration, the IRS will usually limit SFR filings for the past six years.
There’s a couple of factors that play into whether the IRS will file an SFR or not. The first factor is the taxpayer’s compliance history. If the taxpayer has multiple years of not filing returns, then the IRS may look at the taxpayer’s account as aggregate that may decide to batch file SFRs or may decide to go after SFRs for one year.
The second factor is an illegally sourced income or any ill-gotten gains or any criminal activity that the government may be aware of. Government agencies do share information.
And then the third and probably the most important consideration for the government is how much revenue is going to be anticipated from collecting on these SFRs. If you’ve got a taxpayer who is a high-income earner and has been operating off the books, as is commonly the case.
For example, I had a situation with a client who is the beneficiary of a trust. And she’s been the beneficiary of the trust for since about mid-80’s and she has failed to file her returns for since the mid-80’s going forward.
Because of the amount of distributions coming out of the trust that are reported to the client and the size of those distributions, the government decided to start filing SFRs for her and eventually racked up a couple of million dollars in liability.
That’s a really extreme case. Most of the time I will tell you that taxpayers who are above the $100,000 range are those who tend to have SFR filings.
The other things is taxpayers who are below the $100,000 range, if they have wage and income information on file; and generally taxpayer with wage and information on file are a lot easier to prepare SFRs for. You plug in the wage income information system on file, you can easily create a return or a past due tax liability.
Oftentimes, the IRS will be able see through their system, through the wages and withholdings that were issued on W2 orders, whether an SFR is necessary. So other times, the IRS will forego filing SFRs because they view the withholdings as sufficient.
When calling the IRS looking at a taxpayers account, upon coming across SFRs for years that the IRS says are not filed, it’s important to make the determination on whether a return is actually needed and whether it’s going to be beneficial for the client to file. And those are really important considerations to make.
There are other factors that impact an SFR, that impact the decision on whether or not you want to file a return. But, generally speaking what you’re looking for is you’re looking for whether the IRS personnel is asserting a filing requirement.
Does the IRS want this person to file a return or are they satisfied with the SFR filing.