Substitute for Return from the IRS–What is it?

Substitute for Return
An average of 900,000 Americans each year fail to file their federal tax returns.  So, what exactly does the IRS do in response?   Basically, the IRS has established the Substitute for Return Program to establish (“assess”) tax amounts owed by the non-filer, and to also calculate non-filing penalties and interest.

A Substitute for Return (SFR) is a tax return that the IRS will prepare on behalf on its own for the non-filing taxpayer, usually about 2 years after the original tax return would have been due. This tax return is usually prepared in an automated fashion. This means that if you’re self-employed, you’re inevitably going to suffer greatly from a SFR.

Why an IRS Substitute for Return is a bad thing for taxpayers

Essentially, the IRS will prepare the SFR without using any deductions or exemptions that would otherwise have been available to the taxpayer.  Let’s say that you’re a construction contractor who failed to file a return for 2012.   The IRS would have received copies of all of your 1099’s.   So, if those 1099’s total to $300,000 in gross income, does the IRS know that you had to hire out subcontractors to do labor?   Does the IRS know that you had to purchase materials and supplies for these jobs?   If you guess “no” to these questions, you get a prize!

How to Fix a Substitute for Return

Yes, if you discover that there are SFR’s filed on your behalf, you can still file tax returns for those years in question.   I recently had a client who had sold a house for over $500,000 some years ago.    The client’s memory was not good as to the tax filing status due to some family problems that had raged at that time.   When I received the IRS return transcripts, I saw that Substitutes for Return had been filed for two tax years.   The entire sale price of the house was included as income (capital gains); the IRS obviously didn’t care at the time whether there was an original purchase price!

I prepared and we filed signed tax returns for two years, and was able to eliminate over $200,000 in tax debt just by taking legitimate deductions and exemptions.

That was obviously a great victory for the taxpayer, but SFRs can be a huge problem for others, because unfiled returns can potentially lead to the following problems:

  1. criminal prosecution for tax evasion;
  2. greater extensions for your IRS statutes of limitations (by law, the IRS gets only 10 years to collect its tax debts, so if you fail to file returns, you are only giving the IRS a big advantage);
  3. and then finally, SRSs can prevent you from being eligible to wipe out those income taxes through bankruptcy.

If you have questions or comments about Substitutes for Return, let me know below in the comments.

3 Comments on “Substitute for Return from the IRS–What is it?”

  1. Hello,
    Might you be able to tell me when the IRS began its Substitute for Return program as I was unable to do this and might this approach also be used on state income tax returns in PA as well?
    Thank you for you response.

    1. David,
      The IRS has been doing their SFR program for over 20 years. They are simply using their computers to match up W2s and 1099s with taxpayers who haven’t filed returns. The States do it a bit differently with non-filers. Each year the IRS sends each State Tax Bureau a compilation of all taxpayers in their state and what their federal tax returns are. The States can therefore go after each non-filer directly based upon the federal information.

  2. Can one technically pay the IRS the amount on the SFR by sending a check for the amount the IRS claims and call it a deal if the person is busy and does not want to go back and search receipts for deductions and browse through a years worth of financial records? I know it will cost more but I wondered if can one can legally accept the SFR as the amount due and pay it and get it overwith.

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