The IRS Filed a Substitute Income Tax Return

Wondering About “Pennies on the Dollar” When You Really Don’t Owe?

Nov 8, 2009

The IRS knows the substitute returns often overstate the income tax liabilities; however, it is the taxpayer's responsibility to assert their legal income tax deductions.

Non-filing taxpayers often feel hopeless. They have ignored IRS requests for them to prepare their delinquent tax returns, so the IRS filed a substitute return assessing them more tax liability than they can hope to ever begin paying. Meanwhile, the IRS, lacking response from the taxpayer, pursues aggressive collection activities—IRS tax levies and IRS tax liens are filed, garnishments sometimes even get underway.

Does the Taxpayer Really Owe That Money?

The IRS knows the liabilities upon which they are pursuing collection are most likely highly inflated. It is the taxpayer’s responsibility to file a correct tax return. When the IRS files a substitute tax return and proceeds with collection activities (due to lack of cooperation from the taxpayer), they really want a response from the taxpayer. They want to wake up the taxpayer!! They want to get that taxpayer’s attention. They want the taxpayer to submit the correct return (which often results in a much lower tax liability and even a refund, in some cases).

What the IRS Can Provide

Some of the information a taxpayer may be missing can be obtained directly from the IRS. The taxpayer can request a Wage and Income Transcript through the local IRS office, the Taxpayer Advocates Office or any tax professional (EA, CPA or tax attorney) authorized to practice before the IRS.

Wage and Income Transcripts are identified by social security number and name. They show the information that has been reported to the IRS about a taxpayer’s income and some of the tax deductions for the year in question. The tax deductions are rarely taken into account when the IRS files that substitute return for a taxpayer.

The spouse of any taxpayer filing jointly for the subject tax year should also secure a Wage and Income Transcript to be sure all income gets reported on the income tax return.

Also note, for self-employed individuals and other businesses, the interest on loans relating to the business is often reported to the IRS, sometimes as mortgage interest.

What the IRS Ignores on the Wage and Income Transcript

The IRS frequently ignores any tax credits of which they have record (such as foreign taxes paid through investment funds), but rarely misses assessing the 10% penalty for early withdrawal of any retirement accounts. The IRS has records of tuition fees and/or payments made, student loan interest reported as paid, mortgage interest and, often, real estate taxes. (The Wage and Income Transcripts do not include state income taxes withheld.)

Those Missing Itemized Deductions

The bank and credit card statements will contain charges for services, supplies, equipment and other activity. The taxpayer should peruse these statements. Taxpayers should also read through the copies of the canceled checks the bank provides. Churches often keep a record of contributions made from members. Real estate tax amounts can be obtained from the local tax collector’s office.

Inherent in the dates presented in bank and credit card statements is the structure of recreating mileage logs, if applicable, whether for business, medical or charitable reasons. Information regarding stock transactions and basis can often be obtained from the brokerage firm. The taxpayer might contact doctors and dentists to request a statement of out-of-pocket amounts they paid for medical and dental expenses.

Finish the Income Tax Return

The IRS is fully aware when it completes a substitute return that most, if not all, taxpayers will not owe as much in income taxes as that substitute return indicates. Armed with the above information—IRS Wage and Income Transcript, bank statements, and credit card statements, a taxpayer can begin completing the return and show the IRS what their true liabilities are. If a taxpayer is missing business records, there are ways of reconstructing business income and business expenses. And yes, if the taxpayer does not have the funds to pay any amount owing, it’s time to research payment options.

The copyright of the article The IRS Filed a Substitute Income Tax Return in Self-Employment is owned by Jeannine Silkey. Permission to republish The IRS Filed a Substitute Income Tax Return in print or online must be granted by the author in writing.