Taxation & Estate Planning

The damage that can be done by IRS substitute returns, and how to solve it.

By howardlevy

Here is a reason to always filed your tax returns…

I just resolved a case where my clients did not file their 2000 and 2001 returns. This resulted in the IRS making an estimate of their liability by what is known as a “Substitute for Return.”  These estimated returns are most always incorrect and usually overstate the amount owed.  They can turn what should be a refund into a balance due.

The IRS had my clients owing $25,000 even though my clients really did not owe anything.  To make matters worse, an IRS levy was placed on wages to collect the liability, taking $720 per month, an amount my client could not afford.

I prepared original returns for my client, which showed they were actually entitled to refunds.  The returns were personally hand-filed at an IRS walk-in center, and the levy was promptly released as there were refunds due.   A $25,000 liability turned into about $1,000 in refunds (my clients will not receive the refunds - the returns were filed too late). 

Substitute returns can wreck havoc.  They usually have the wrong filing status. There are no dependency exemptions.  There are no deductions for mortgage interest and charitable contributions.  If a business is operated, the tax is calculated on the total gross income - no allowance for business operating expenses.

I have seen well-intentioned clients with no income other than stock sales get tangled up in IRS substitute returns.  Since their stock was sold at losses, they believed that they did not have to file.  But the IRS did not know that - all they know is the gross sales price.  The IRS calculated a significant liability, and a tax levy was issued.  After I was retained, original returns were filed, with the stock losses calculated and reported. The returns had a refund, and a levy release was secured.

If you have not filed, the damage done by IRS substitute return can be significant - incorrect balances owed, tax levies, and lost refunds. Try not to ignore IRS warning notices that they are considering filing substitute returns.  It can be fixed, but it is best to be addressed sooner rather than later.

Full post as published by IRS and the Law on February 25, 2009 (boomark / email).