Have unfiled tax returns? Don’t Wait!

The IRS estimates that up to 10 million Americans have unfiled tax returns.    Our office meets with many new clients with exactly this problem.  Most of these come into my office stressed out after many sleepless nights worrying about their tax situations and how they’re going to handle it.   Yes, good people can sometimes get into bad jams, so how to get out?

The IRS Six-Year Rule

As a general rule, the IRS looks for non-filers to file the last 6 years of unfiled returns.  The IRS has issued Policy Statement 5-133 which specifically states that “taxpayers must file six years of unfiled returns to be in good standing with the IRS.”   I’ve met with many new clients who have not filed returns in more than 10 years.  This IRS rule comes as good news to them.

Getting Your Income Records

For many taxpayers with unfiled returns, they are stressed out because they can’t locate old W-2s and 1099’s.  Maybe they’ve moved residences or have suffered from a flood or fire, or have gone through a divorce (and their ex-spouse has thrown away their tax paperwork).   If you can’t find your income records, then I can get them from the IRS going back for the 6 year period.  The IRS retains all W2s and 1099s going back for 8 or 9 years, and I can get those records in a day or two.  If you’ve been engaged in a business that sells to non-commercial customers, then you likely won’t have a record of 1099’s.  In that case, you can order your bank statements going back for the years in question, and go through your bank deposits to ascertain your income.

Putting Together Your Business Expenses

The more difficult task for many taxpayers will be to find their receipts for business expenses.  What happens however if you can’t locate your expense receipts?  The answer is found in a famous 1930 court case involving a famous Broadway producer named George M. Cohan.  Mr. Cohan had incurred a lot of expenses traveling to theater venues across the country, but was unable to locate his expense records.  When he attempted to claim these expenses on his tax returns, the IRS disallowed his expenses.  Mr. Cohan appealed in court, and the Second Circuit Court of Appeals ruled that Mr. Cohan could in fact claim reasonable estimates of his business expenses.   To this date, this is known as the Cohan Rule.

For example, if you’re a contractor, you undoubtedly have spent a lot on building supplies, tools and on fuel going to job sites.  You can compile a reasonable estimate of your materials, supplies and tool purchases.  You can estimate your mileage by reviewing your calendar and list of jobs.  We had one client who had ordered all of his building supplies from Home Depot and he was able to get a printout of all of his purchases for the year.  Just by listing those supplies, he was able to reduce his IRS tax debt from $30,000 to $10,000.

Don’t Lose Your Tax Refunds

Another IRS rule is that if you are owed tax refunds, the IRS will only pay refunds for tax returns filed within 3 years.  So, you don’t want to wait too long to file your returns.  Otherwise IRS Code Section 6511 permits them to keep your refund!

When the IRS Files it Own Return

Often, if you have not filed a return, the IRS will notify you that it intends to file a return for you unless you file it within a certain period.  You do not want the IRS to file the return, because they will not claim any business expenses in your favor, and will also not claim any tax exemptions or deductions such as dependencies or mortgage interest and real estate taxes.

If the IRS does file its own return, it’s called a “substitute for return“.   You can eventually file a correct return.  By doing this, you can reduce your balances and correct the record, but this will take more time.

Resolving Your Tax Balances

Once all of your returns are filed, then the IRS will now consider some form of resolution, whether it’s a payment plan or an Offer in Compromise.  A case we had several years ago, we had a new client who knew that they owed the IRS.  The IRS had already issued a wage garnishment on the wife’s paycheck, so time was of the essence.  The husband had started a contracting business about 4 years previously, but they had not filed returns for those 4 years.  We worked with the clients to quickly prepare and file the returns.

Once the clients had signed the returns, I contacted the IRS and immediately obtained the release of the wage garnishment.  The returns were all faxed to the IRS and I was able to obtain penalty relief from their oldest tax year.  The total amount owed was $29,000 and the abated penalties amounted to $4,500.   So, with a balance of $24,500, the IRS agreed to a monthly payment amount of $345, which the clients were easily able to afford.

Getting Back on Track

Once you’ve filed all of your back tax returns, you can finally breathe a sign of relief.  Moreover, you can now purchase real estate or refinance a mortgage, if that is your wish.  With unfiled returns, those options are off the table.

If you have questions about unfiled returns, please call our office for a free consultation.

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