Ask The EDD Attorney – Have You Failed To File Income Tax Returns? The IRS And FTB Can Do It For You – And That Is When Your Troubles Begin
By Robert S. Schriebman
August 26, 2015
Introduction
On August 12, 2015 the United States Tax Court published its decision S.A Whittington, TC Memo 2015-152, Dec. 60,374(M). Mr. Whittington, it seems, received compensation for services from an LLC together with income from partnership enterprises, gambling winnings and miscellaneous other sources. However, Mr. Whittington failed to file income tax returns. After repeated requests from the IRS to file delinquent returns the IRS, based on available internal information, prepared returns for him together with accruing penalties and interest. Can the IRS do that? This article will discuss the legality of the IRS and FTB preparing “dummy returns” for non-filers and assigning collectors to collect these estimated assessments.
Can They Do That?
May the IRS and FTB legally prepare and file your income tax return if you have failed to do so? In one word – Yes. Let me explain.
Let’s take the IRS as an example. Pursuant to IRC § 6020(b), it is perfectly legal for the IRS to prepare a return if you fail to do so. IRC § 6020(b) states as follows:
“If any person fails to make any return required by any internal revenue law or regulation made there under at the time prescribed therefore, or makes, willfully or otherwise, a false or fraudulent return, the Secretary (of the Treasury) may prepare such return which, being signed by such person, may be received by the Secretary as the return of such person.” (added)
The FTB has a similar provision and process.
This process is known as “SFR” or Substitute for Return. If the IRS or FTB prepares an SFR they will also add all the late filing and late payment penalties together with daily compounding interest that runs from the actual due date of the return, i.e, April 15 for most individuals. The penalties and interest add an average of an additional 40% to the basic income tax bill.
The SFR – That Is When Your Troubles Begin
What are the troubles associated with the IRS or the FTB filing an SFR return on your behalf? To begin with the IRS and FTB share information. The SFR will be prepared from W2, 1099, or other sources of income data sent to the IRS. The SFR will be prepared showing gross taxable income. A standard deduction is all you will be allowed on your SFR against gross taxable income. If you have itemized deductions, exclusions, credits, or losses, these will not be reflected on the SFR. Therefore, you will be subjected to the maximum possible tax rate with the minimum allowable deductions together with penalties and interest. Keep in mind that the interest factor is compounded daily from the original due date of the return.
Is There An SFR Fix?
Is there anything you can do to fix the SFR situation? Yes there is. You are always allowed to file late actual returns taking advantage of every legal loophole under the IRS and FTB codes. However, if you wait too long you may lose valuable refunds. Assuming that you file a valid late return, the IRS will remove the SFR and substitute the data in the actual return in its place. Of course there is no guarantee that you will not be audited. The IRS and FTB assigned collector will place the collection efforts on hold to give you time to prepare and file the actual return in place of the SFR version.
SFRs and Bankruptcy
People who owe IRS and FTB income taxes may be eligible to have their tax debt discharged in bankruptcy. It is an unfortunate and common myth that income taxes cannot be discharged in a bankruptcy proceeding such as Chapter 7. I compare bankruptcy eligibility to cooking a fine soup. You have to have the right ingredients and the right amount of time. One of the main ingredients to a Chapter 7 discharge is an actual filed income tax return. I do not pretend to be a bankruptcy expert. If you are thinking about discharging your old IRS and FTB tax debts in bankruptcy I recommend that you consult with a bankruptcy attorney who has been certified by the State Bar of California. For example, I am a Certified Taxation Law Specialist. There are Certified Bankruptcy Law Specialists. It is also very important for you to make certain that your bankruptcy attorney is experienced and knowledgeable about discharging taxes in bankruptcy – not every bankruptcy lawyer is knowledgeable.
What has SFRs to do with bankruptcy discharges for taxes? In order to be eligible for a legal bankruptcy discharge for taxes, tax returns must first be filed before one is eligible for discharge. An SFR does not count as a filed tax return. Let me tell you the sad case of Adam.
Adam owed the IRS for back taxes. There were 7 years involved in Adam’s matter. In 4 of the 7 years Adam filed timely tax returns. However in 3 of those 7 years Adam had SFRs. Adam hired a bankruptcy attorney who was not knowledgeable when it came to taxes. The bankruptcy attorney failed to do a “discharge analysis.” The attorney filed a Chapter 7 proceeding and Adam was confident that all of his old tax headaches were over. Unfortunately Adam’s attorney died a few months after Adam was discharged in bankruptcy. All of a sudden Adam found the IRS coming after him for taxes owed on SFRs. Adam was out-on-a-limb. The IRS was right – there are no discharges for SFR returns. Adam’s attorney was dead; his office closed. If Adam wants to be discharged for the SFR returns, he must prepare actual returns and start the bankruptcy process a second time.
Conclusion
If the IRS or FTB sends you notice that they are preparing SFRs in place of returns that should have been filed, it is very important for you to gather up your paperwork and take it to a reputable tax return preparer for preparation and filing. This is especially true if you have itemized deductions, credits, or excludable income. If your long-range plan calls for a possible Chapter 7 discharge, you must have actual prepared returns on file with the IRS and FTB beforehand. Choose your bankruptcy attorney with great care.
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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure”, both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure”, both published by Commerce Clearing House.
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