Under Internal Revenue Code, Section 6620, if a Taxpayer does not timely file a U.S. tax return, the IRS is authorized to prepare and file a U.S. tax return for that Taxpayer based on the knowledge that it has on hand. The return prepared by the IRS is called a Substitute for Return (SFR). The Automated Substitute for Return (ASFR) program assists the IRS with enforcing filing compliance regarding Taxpayers who have not filed individual income tax returns but appear to owe a tax liability. In 2015, the IRS suspended the ASFR program due to resource constraints. However, IRS resumed selecting cases for the ASFR program on May 21, 2019.
In Fiscal Year 2019, the ASFR program collected $87.5 million. IRS is working to refine the selection algorithm used to select cases for the ASFR program, including third-party documentation and a Taxpayer’s prior filing history.
An SFR is not in the best interest of a Taxpayer because the Taxpayer may owe IRS an inflated amount. IRS states on Notice CP2566: “Keep in mind that this amount may be higher than what you would owe if you filed your own return”.
The purpose of the ASFR program is to assess tax liabilities by:
- Securing valid voluntary delinquent tax returns.
- Computing tax, interest, and penalties based on income information submitted by payers when no return is filed.
What sources of information does the IRS ASFR utilize:
- Information returns from third parties (such as Forms W–2 and 1099)
- Construction of tax returns for certain non-filers based on that third-party information
- Assessment of tax, interest, and penalties based on the substitute returns
Most Taxpayers learn that the IRS has prepared an SFR when they receive a letter in the mail. The first correspondence (assessment letter) from the IRS is Notice CP2566. This notice will direct a Taxpayer to:
- Immediately file the delinquent tax return or
- Accept IRS’ proposed assessment by signing and returning the Response form, or
- Call IRS if a Taxpayer thinks that she is not obligated to file a tax return for the period being assessed.
What does all this mean and why is it important?
The tax world is clearly becoming more interconnected and globalized with countries exchanging financial information about each other’s citizens through FATCA and the Common Reporting Standard (CRS). Every international decision a taxpayer makes (whether he or she is residing in the U.S.), can trigger something, or create an alert.
Suppose that a U.S. Taxpayer does not reside in the U.S., does not report offshore accounts or file tax returns. Foreign financial institutions will report the Taxpayer’s reportable account balances and income earned on the account(s) as they are obligated to do under FATCA or CRS. The IRS will receive the information, and cross-reference it with its own previously received information. IRS could prepare an SFR and send a notice to a Taxpayer. If a Taxpayer cannot pay, and the amount due is over $50,000.00 and becomes delinquent; well then, a Taxpayer may lose his or her passport.
Taxpayers should not be victims of their own making and should consult their tax specialist if they are out of compliance. And the time to do this is now!