If you have unfiled tax returns, it’s important to understand the IRS’ enforcement procedures. The IRS takes non-filing seriously and can impose civil and criminal penalties (including jail time). However, an experienced tax lawyer can help you file your unfiled returns and resolve your tax problems.
The IRS Identifies and Penalizes Non-Filers
According to IRS studies, roughly ten million Americans fail to file their tax return each year. While many of these non-filers simply made an honest mistake, others are intentionally avoiding their tax liabilities. The IRS identifies most, if not all, of these non-filers. Using sophisticated software tools, a multidisciplinary task force (including auditors and agents) identifies and investigates non-filers.
You may face both civil and criminal penalties for unfiled tax returns. Civil penalties involve:
- Loss of your tax refund,
- Loss of certain tax credits, and
- Tax liens and levies.
You may also have problems filing for bankruptcy if you have unfiled tax returns. The IRS does not have a civil statute of limitations for unfiled tax return charges. In other words, it can seek civil penalties at any time — even if the unfiled return is decades old.
In more serious cases, the IRS can press criminal charges. Criminal penalties include:
- Failure to file a tax return: up to a year in prison and $25,000 in fines for each unfiled return,
- Filing a fraudulent tax return: up to three years in prison and $100,000 in fines, and
- Tax evasion: up to five years in prison and $100,000 in fines.
Tax return fraud and evasion are both felony charges. In criminal cases, there is a six-year statute of limitations (the IRS must file charges within six years of your non-filing).
Voluntary vs. Enforced Compliance
Don’t panic if you have unfiled tax returns. However, it is important that you act quickly and seek help from a tax lawyer. A tax lawyer can help you voluntarily comply with the IRS, which may help you avoid serious penalties. However, once the IRS begins an investigation of your unfiled tax returns, your options may become limited.
The Benefits of Voluntary Compliance
It’s always best to voluntarily comply with the IRS. If you have unfiled tax returns, you can use the IRS’ “voluntary disclosure” procedures to file these returns. Sometimes called an amnesty program, voluntary disclosure may help you avoid serious criminal charges. You qualify for voluntary disclosure if you:
- Voluntarily report your unpaid tax returns,
- Only have legally-obtained income,
- Report your non-filing before the IRS initiates a criminal investigation,
- Submit an accurate tax return and cooperate with the IRS, and
- Fully pay your tax debt or make a legitimate payment arrangement (such as an installment agreement).
It is vital that your late return is accurate and fully discloses your income. If you submit an inaccurate tax return, you may face criminal prosecution.
IRS Investigations and Substitutes for Returns
If the IRS identifies you as a non-filer, it will begin sending notices (sometimes called CP Notices). Typically, the CP Notices are sent over a period of 22 to 26 weeks. If you ignore these notices (or fail to respond), the IRS will enforce compliance. Enforced compliance may involve:
- In-person contact from a revenue officer,
- An investigation of your income, involving contact with your employer, family members, neighbors, and others, and
- The IRS’ preparation of your unfiled tax return (called a Substitute for Return).
When the IRS prepares a Substitute for Return (SFR) for you, the tax bill computed by the IRS is usually significantly higher than it would be if you prepared an actual return. The IRS uses a filing status of “single” or “married filing separately” with just one exemption (the taxpayer) and with just the standard deduction (no mortgage interest, no state tax deduction, no contributions, etc.). The IRS also uses a cost basis of zero for any stock you may have sold during the year.
Because the significant penalties and interest added are based on the unpaid tax amount, higher tax means higher penalties and interest, too.
Once the IRS has prepared a Substitute for Return for you, you must follow certain procedures if you want to reduce your liability to what it truly should be based on your particular circumstances by filing your own late tax return.
Badges of Fraud
The IRS has dumped substantial money into finding those who defraud the federal government on their tax returns. One might wonder if this division brings in more money than it costs. Even it doesn’t, it scares most people into filing their tax returns properly and reporting all of their income. That, in essence, is the point.
The IRS publishes a large amount of information about its process for identifying fraud. You can find it online with a simple Google search. On this page, it identifies what it terms “badges of fraud”. In other words, these are markers that the IRS uses to define the scope of fraud and possible ways that taxpayers might wiggle out of paying their taxes. These are not “merit” badges. These are crimes for which an individual can be convicted in federal court. They have unpleasant penalties. They can be divided into different categories. More information on that is below.
Income Badges of Fraud
Income badges of fraud include earned income that has been left off of a tax filing. The IRS will recognize the omission as fraud in certain circumstances. These include:
- Omitting items of the same type as those that were included on a tax return;
- Omitting entire sources of income (usually from a side gig or contract work);
- Major increases in net worth over a period of a few years;
- An imbalance between personal expenditures and net income;
- Bank statements that do not match reported income;
- Concealed bank accounts or other assets;
- Failing to deposit business receipts to business accounts;
- Hiding or misrepresenting the source of receipts.
In other words, the IRS has its eye on certain types of behavior that signal fraud in reported income. While the IRS might not necessarily press charges if you voluntarily agree to submit your correct earnings and pay taxes on them, they
Deduction Badges of Fraud
An obvious way around paying substantial taxes is to claim that your expenses were higher than they actually were. Since only the net earnings of a business are taxable, an individual might think it’s clever to try to overstate their deductions. The IRS identifies several badges that clue them into such behavior. Those include:
- Overstatement of deductions;
- Personal expenditures listed as business expenses;
- Fictitious or non-existent deductions;
- Fraudulently claiming fictitious people or your dog as a dependant;
- Disguising loans of trust funds as deductions.
Bookkeeping Badges of Fraud
Keeping two sets of books is the oldest trick in the book. Nonetheless, people still do it and the IRS still catches them doing it. If they do, they will charge you with fraud. Nowadays, they may produce fake invoices, backdate records, or producing other false documents. This too is a crime known as “uttering false documents”.
Allocation Badges of Fraud
Some very clever people get around paying their taxes by distributing profits to nonexistent partners. In other cases, they try to couple items with a lower tax rate with those with a higher tax rate. The IRS considers that fraud.
Taxpayer Conduct: How They Know Someone Is Committing Fraud
Generally, the IRS doesn’t want to send people to prison. They just want their money. However, they get peevish when someone directly lies to them or tries to deceive them. In those cases, they will charge a taxpayer with fraud. Other instances might include:
- Attempting to hinder an audit;
- Destroying books or other potentially damaging information;
- Transferring large amounts of assets prior to an audit;
- Consistent failure over the course of several years to report income;
- Submitting any false documents or false information on official forms.
Don’t Wear an IRS Badge of Fraud
By the time they begin conducting an audit or show up in person, it’s time to come clean. A tax attorney can advise you and anything you tell your attorney will be confidential. Importantly, don’t try to hide lies with more lies. The IRS will likely give you a chance to repay your debt without using more aggressive methods.
The IRS is adept at sniffing out irregularities in record keeping and unearthing some of the most clever schemes. A tax attorney can help you mitigate some of the damage and ensure you regain compliance with the IRS.
The Importance of Attorney-Client Privilege
Unlike other tax professionals, your discussions with your tax lawyer are fully privileged. In other words, your lawyer cannot disclose the substance of your conversations during either a civil or criminal investigation. In comparison, your discussions with an accountant are only privileged for civil matters. An accountant must disclose your information during a criminal prosecution. And, conversations with a “tax preparer” are never privileged.
Your discussions are protected by attorney-client privilege. Therefore, you can discuss your unfiled tax returns candidly with your lawyer. This allows your lawyer to get the best possible information — allowing him or her to craft a solution tailored to your needs and goals.
Consult With a Virginia Tax Lawyer About Your Unfiled Tax Returns
If you have unfiled tax returns, contact the Sodowsky Law Firm immediately. We guide our clients through the compliance process and will negotiate with the IRS on your behalf. Contact us to schedule your confidential and personalized evaluation.