Delinquent Returns & Nonfilers

We frequently come across clients, especially small business clients, who have not filed their tax returns for several years. Most such non-filers voluntary come forward before being contacted by the IRS. We’ve also seen nonfilers contacted by the IRS Collections or Criminal Investigation division.

Small business clients who voluntarily file their delinquent returns often end up with a large amount of unpaid tax debt if they had not been making estimated tax payments. There are options available for resolving the debt, but the inability to pay the debt should not be a reason to not file. Not filing tax returns and waiting for the IRS to contact you will guarantee you to be in a much worse situation than voluntarily filing them and making arrangements with the IRS on the debt.

IRS investigations of non-filers

A taxpayer who has serious tax filing delinquency may be referred to examination. Examiners encounter nonfilers in several ways. For example,

  • From related cases/spin-off examinations
  • As project cases
  • As referrals from other functions

When examiners discover during any examination that a taxpayer has failed to file required federal tax returns, they will, before soliciting any returns:

  1. Determine the taxable periods for which the taxpayer was required to file returns.
  2. Ascertain the reasons why the taxpayer failed to file the required returns.
  3. Determine whether any indications of fraud exist.

Fraud considerations

When indicators (signs) of fraud are uncovered, the examiner will initiate a discussion with their group manager. If the group manager concurs that there are indicators of fraud warranting fraud development, the examiner will contact the fraud technical advisor (FTA) assigned to that area.

The FTA will assist in identifying affirmative acts of fraud and in developing an investigative plan of action. The FTA will also help determine whether or not a criminal referral should be made.

Substitute returns

If an examiner determines that the failure to file tax returns was not fraudulent and the taxpayer does not voluntary file his returns, the IRS will prepare a substitute return. The IRS filing a substitute return is generally not in a taxpayer’s best interests. The IRS will include all income from available sources without any deductions or credits.

Civil penalties for failure to file

Minimum Failure to File – IRC 6651(a)

The minimum failure to file (MFTF) penalty applies to any failure to file a tax return required under Chapter 1 of the Code (IRC sections 1 through 1400).

Failure to File a Tax Return – IRC 6651(a)(1)

IRC 6651(a)(1) imposes a penalty for failure to file a tax return by the date prescribed (including extensions), unless it is shown that the failure is due to reasonable cause and not due to willful neglect.

Fraudulent Failure to File – IRC 6651(f)

The fraudulent failure to file (FFTF) penalty under IRC 6651(f) increases the FTF penalty under IRC 6651(a)(1) from 5% a month to 15% a month, and the maximum penalty from 25% to 75%.

Criminal penalties for failure to file

Taxpayers may face criminal prosecution, although rare.

Attempting to Evade or Defeat Tax – IRC Sec. 7201

Under IRC Sec. 7201 the penalty is a fine of up to $100,000 and imprisonment for up to five years.

Willful Failure to File a Return – IRC Sec. 7203(b)

The penalty for a willful failure to file a return under IRC Sec. 7203 is a fine of up to $25,000 and imprisonment of up to one year or five years as a felony if the failure to file involved a return relating to cash received in a trade or business under IRC Sec. 60501.

Making False Statements on a Return – IRC Sec. 7206

Penalty is a fine of up to $100,000 and imprisonment for up to three years.

Attempting to interfere with Administration of Internal Revenue Laws – IRC Sec. 7212

The maximum penalty is $5,000 and imprisonment for up to three years.

Attorney-client privilege

For serious nonfiler cases, the client should hire an attorney and not an accountant. An attorney will engage with an accounting firm on your behalf (a “Kovel accountant”) for bookkeeping and tax preparation. Attorney-client privilege is a client’s privilege to require the attorney to keep confidential communications secret. That privilege would not extend to an accountant that you hire yourself. Attorney-client privilege can prevent the IRS from obtaining from the attorney or the Kovel accountant, for instance, any information concerning the location and amount of the nonfiler’s assets, and the source and amount of the nonfiler’s income.