When the Internal Revenue Service (IRS) conducts an audit, it reviews or examines an individual's or organization's accounts and financial information in regard to their taxes. Audits can go back three years, six years or indefinitely, depending on the reason. In the case of unfiled tax returns, the IRS can go back to any point in a person's tax history.
How the IRS Audits Tax Returns
In most cases, the IRS goes back about three years to audit taxes. For example, if an individual's 2018 tax return was due in April 2019, the IRS acts within three years from the due date to audit that person. If the taxpayer never filed or filed late, the statute of limitations does not start until they file. Sometimes the IRS extends audits to six years when a person or organization has significant unreported domestic or foreign income, or has greatly embellished their deductions.
There are two instances during which the IRS can take unlimited time with an audit. The first is if the taxpayer hasn't filed any returns for a specific tax year or years. In that case, the statute of limitations has not yet begun. Until they file tax returns, even if they owe from a decade ago, the IRS can still audit them. The second is in the event that the agency has information or knowledge that a taxpayer has acted fraudulently.
Criminal Consequences for Not Filing Tax Returns
People may get behind on filing taxes for any number of reasons. They may have had a death in the family or suffered an illness. Before they know it, several years have passed and perhaps they are too afraid or don't know how to make things right with the IRS. While this can be tempting to ignore, unfiled tax returns can lead to criminal repercussions, like high penalties and even time behind bars.
Evading one's tax assessment and payment can lead to a prison sentence of up to five years and fines of up to $250,000. However, the IRS has a time limit for filing criminal charges against someone committing evasion. It must file within six years from the due date of the unfiled tax return. Those who willingly file the missing returns on their own rarely receive criminal charges.
Collecting Unfiled Taxes
While there is a hard time limit for filing criminal charges, the IRS has no such time limit to collect on unfiled tax returns. A person who believes they are off the hook after a decade or two may learn that the agency has not forgotten about them. Not only can the IRS collect the taxes owed, but it will also collect interest and penalties for the years not filed.
Only after a person or organization files their unpaid taxes does the agency, once again, have a time limit of 10 years to collect the money. However, state tax agencies may have longer. For example, California can attempt to collect monies owed for up to two decades after a person files.
Defining a Substitute for Return
In some instances, the IRS will file a delinquent return on behalf of the taxpayer who has not filed one themselves. It bases a Substitute for Return, also known as an SFR, on information it has from other sources and does not include exemption or deductions on the return. Furthermore, it may overstate a person's actual tax liability.
After it files the SFR, the IRS sends a notice to the person who owes back taxes to accept its filing. If they don't respond, the agency issues a statement of deficiency. At this point, it can start the collection process and may place a levy on a person's earnings or bank account, or a lien against their property. The person who owes back taxes does not have to accept the SFR – they can file a return for the missing years and include their deductions. Chances are, by doing so themselves, they will have decreased the money they owe the IRS.
How to File Missing Income Tax Returns
A person or organization owing money to the IRS may want to attempt payment before the agency seeks them out. There is no time limit for doing this. However, once they start the process, they have a maximum of three years to claim their refund. Before filing overdue returns, taxpayers should seek the advice of a CPA or tax attorney.
It is beneficial for those avoiding filing their missing tax returns to make things right with the IRS. Not only does it offer peace of mind, but it can put an end to issues such as having trouble obtaining loans; if a person can't provide tax returns to prove their income, they may face a loan denial. Filing taxes can also protect their benefits – for example, independent contractors who haven't paid their taxes won't get credit toward disability or Social Security benefits.
Negotiating the Tax Bill
Negotiating a tax bill is not out of the question if the tax assessment is too high to pay. It is possible to have penalties removed, as they can equal 15 to 20 percent of monies owed to the agency. A person can file IRS Form 843 to request a reduction of taxes, interest, penalties and other fees.
Those who owe the IRS a tax debt of $10,000 or more can ask for a Partial Payment Installment Agreement. This allows the IRS to accept a smaller amount than what a person owes, but it will only agree to the arrangement if it is evident that the taxpayer's monthly installment payments won't cover the total taxes due. An offer in compromise (OIC) between a taxpayer and the IRS also allows the agency to settle for less than the full amount owed. However, if a taxpayer shows they can pay the liability through installments, they may not be eligible for it.
Michelle Nati is an associate editor and writer who has reported on legal, criminal and government news for PasadenaNow.com and Complex Media. She holds a B.A. in Communications and English from Niagara University.