IRS Substitute for Return
If you fail to file a tax return, the IRS can make the tax return for you.
The IRS will do this based on whatever knowledge is available or can be obtained. This usually means that the IRS will add in items of income reported to the IRS by third parties, such as wages reported to the IRS on a Form W-2 and other payments reported to the IRS on a Form 1099. It will not add other tax deductions or credits.
The result is usually a large tax liability. The IRS’s internal training materials describe the IRS-prepared tax return as follows: “it may overstate actual tax liability.”
This is why IRS-prepared returns fall into the category of “problem tax returns.”
This IRS-prepared tax return is commonly referred to as a “substitute” return or a “substitute for return” or “SFR.”
If the IRS prepared a tax return for you or you have questions about not filing a tax return, this article is for you.
We’ll describe the IRS SFR returns, explain when the IRS prepares these returns, and describe the consequences of SFRs.
IRS Authority to Prepare and Execute Substitutes for Returns
Section 6020(b)(1) allows the IRS to prepare and execute SFRs:
If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.
The term “shall” suggests that the IRS is required to prepare SFRs. The courts have not agreed. They have generally said that the IRS is not required to prepare SFRs. See, e.g., United States v. Maggi, No. 98-5570, 1999 WL 96651, at *2 (6th Cir. Feb. 5, 1999); United States v. Stafford, 983 F.2d 25, 27 (5th Cir. 1993); United States v. Powell, 955 F.2d 1206, 1213 (9th Cir. 1991); Schiff v. United States, 919 F.2d 830, 832 (2d Cir. 1990); United States v. Verkuilen, 690 F.2d 648, 657 (7th Cir. 1982); United States v. Tarrant, 798 F. Supp. 1292, 1303 (E.D. Mich. 1992).
It should also be noted that the IRS’s authority to prepare and execute SFRs applies if you file a false or fraudulent tax return. If the IRS deems your return to be fraudulent, it can file its own return for you.
IRS Procedures for SFRs Under Section 6020(b)
Treasury Regulation § 301.6020-1(b)(2) provides the procedures the IRS has to follow to prepare and execute a valid SFR.
It says that the document (or set of documents) has to be signed by an authorized Internal Revenue Officer or employee. The signature can be “handwritten, stamped, typed, printed or otherwise mechanically affixed.” The document (or set of documents) also has to:
1. Identify the taxpayer by name and taxpayer identification number,
2. Contain sufficient information from which to compute the taxpayer’s liability, and,
3. Purport to be a return under Section 6020(b).
The IRS usually uses a Form 13496, IRC Section 6020(b) Certification, for this purpose. Alternatively, it may send a Letter 2566, 30 Day Proposed Assessment 910 SC/CG (this is an “ASFR,” an automated substitute for return, as it is generated by the IRS’s computer system, which includes an electronic signature by the IRS).
The IRS’s SFR cannot be a “dummy return”, i.e., page 1 of a Form 1040 showing only your name, address, and Social Security number. See, e.g., Millsap v. Comm’r, 91 T.C. 926 (1988). A “dummy return” that has an IRS Revenue Agent’s Report attached may be sufficient, however. See, e.g., Cabirac v. Comm’r, 120 T.C. 163 (2003)
Status of Returns Prepared under Section 6020(b)
As a general rule, a substitute for return is good and sufficient for all legal purposes. The tax code says this. It says that“any return… made and subscribed by the Secretary shall be prima facie good and sufficient for all legal purposes.”
The regulations mirror this. Treas. Reg. 301.6020-1(b) says that “any return made in accordance with [Treas. Reg. 301.6020-1(b)(1)] and signed by the commissioner or other authorized Internal Revenue Officer or employee shall be good and sufficient for all legal purposes except insofar as any Federal statute expressly provides otherwise.”
This does not mean that everyone will accept an SFR or that you should not file your own return.
Here are a few exceptions when an SFR is not “good enough.”
1. The SFR cannot be the basis of an IRS assessment. This means that the IRS still has to go through the steps to officially notify you of the tax it wants to charge you with before it can record the tax due on your IRS account.
2. The SFR cannot be filed jointly. Put another way, the IRS cannot make an election for you to file jointly by filing a joint SFR. This means that you can file a tax return after the SFR to file jointly, as you have not already made an election to file separately by way of the SFR. See Millsap v. Commissioner, 91 T.C. 926 (1988); Rev. Rul. 2005-59, 2005-37 I.R.B. 505.
3. The SFR is not a tax return for purposes of the itemized deduction election. The IRS cannot make this election for you. So if you want to itemize your deductions, you should file your own return.
4. The SFR does not start the IRS’s clock running. By this, I mean that the normal three-year time period for the IRS to assess additional tax is not started when an SFR is filed. You have to file your own return to start this clock running. The same concept applies to the IRS’s 10-year collection statute. The 10-year period only starts running when you file your own tax return. See Treas. Reg. § 301.6020-1(c)(1), referring to IRC § 6501(b)(3) and Treas. Reg. § 301.6501(b)-1(e).
With that said, the IRS will make an assessment based on the SFR. The IRS takes the position that the assessment starts the running of the collection statute. This uncharacteristic act of leniency is surprising as one would think the IRS would apply the unlimited collection period that applies when a tax return is not filed. You can find the unlimited time period rule in I.R.C. § 6501(b)(3) and support for the IRS’s position in CCA 200149032.
5. The SFR is not a tax return if you want to discharge taxes in bankruptcy. As a general rule, you have to file tax returns three years before filing a bankruptcy petition to be eligible to discharge your tax balances. You can find this rule in 11 USC § 523, which is part of the bankruptcy code.
You can see the theme here. It is usually advisable to file your own returns even if the IRS has already filed a SFR for you.
There is No Failure to File Penalty
But all is not bad with SFRs. There is at least one good thing. The SFR is not a tax return for purposes of the failure to file penalty. The IRS cannot assess a failure to file penalty if you do not file a tax return.
So by not filing a late tax return, you can avoid this penalty. Here is a case that discusses this topic: Cabirac v. Commissioner, 120 T.C. 163 (2003).
What to do if the IRS Files a Substitute Return?
The discussion above should give you the answer to this. You will usually want to file your own tax return.
Note that you do not have any limit on the time you can file your return given that the SFR is not a real tax return. So you can file these returns even though the tax year has long passed.
In deciding whether to file your own tax return, you also have to factor in the failure to file penalty as the IRS will assess this penalty. So you should compute the amount of tax you will owe, compare that to the amount of tax the IRS wants, and see if the difference exceeds the failure to file penalty.
You can read about the failure to file penalty here, if you want to figure out that amount.
Experienced Tax Return Attorneys
We are tax attorneys in Houston, Texas. We help clients with tax returns, including IRS substitute for returns.
If you are ready to get started or want to talk about your case, please call us at (713) 909-4906 or schedule an appointment to discuss your tax return with a tax lawyer.
Tax Return Articles
If you want to read even more about these topics, you can do so here: even more about problem tax returns.