Have you ever wondered what happens if someone never files a tax return? The IRS has the ability to create a return on your behalf called a Substitute for Return or SFR.
Generally, unless you are self-employed, it’s easy for the IRS to create a return for you. Employers file Form W-2, which reports your wages and withholding. Banks and brokerage firms report your interest and dividends on 1099 forms. All of this and more are filed with the IRS. Therefore, information is readily available for a return to be created without your input.
And don’t count on the government giving you any credits or deductions you may be eligible for! IRS will not take into consideration whether you should be filing a joint return, have dependents you can claim, or have any other deductions or credits that could reduce your tax bill.
If you are self-employed, you’re not off the hook either. The IRS knows your occupation through licensing databases and prior year disclosures, and statistics are available to estimate what someone in your profession earns. Let’s say you are a hairdresser: the IRS knows based on audits of salon businesses what the average hairdresser makes in a day, including tips. The result could be a staggering tax bill!
Besides the fact that you won’t receive deductions and credits in the event an SFR is created, there is no statute of limitations since a return was never actually filed. That means there is no time limit for an audit or collection. The IRS also shares information with states, which means if your state has an income tax, you will be hearing from them as well.
If you haven’t filed returns and this happens, you will receive an IRS notice proposing to assess taxes based on the substitute return created. It is recommended that you file a return as soon as possible in order to trigger a reconsideration of the SFR. This will also start the statute of limitations on collections and audit.
Remember, it is almost always better to file your own tax return rather than allowing IRS to prepare an SFR for you. Even though you are still able to file your own return within a certain timeframe after an SFR is created, it may be subject to more scrutiny since the IRS must accept and process the return in place of the SFR. Avoid this from the start by filing your tax returns in a timely fashion!