Unfiled returns are what brings most of our clients in this area of our practice in to see us. It is not uncommon to have somebody need to file seven or eight years of returns. Sometime there is money due and sometime there are refunds. Let’s see what happens when returns aren’t filed.
The first thing that happens when you don’t file a return is the IRS takes all the income reported in your Social Security number and determines whether a return was required and if a balance is due. If they determine that your income and tax withheld would have generated a refund you will never hear from them. They will not tell you that you have a refund. Nor will they send you a refund. It is lost. You snooze you lose.
If they determine there is enough income that there is a balance due, a Substitute For Return (SFR) is filed by them on your behalf. You almost never want them to do this. They will take the filing status of the last return filed as a starting point. For example, if you’re married, they will use married filing separately as your filing status. That is a higher tax rate than married filing a joint return. You will not get an exemption for any children. You won’t get a deduction for any itemized deductions. This includes medical expenses, real estate taxes, mortgage interest, contributions, or miscellaneous expenses such as work related expenses or gambling losses. If you are self-employed it’s even worse. You will get no business deductions. You will not get any credits. The assumption is that all the income is taxable and the self-employment tax is due on all of the income.
Should you ever get a notice that no return was filed you need to file the correct return immediately in order to determine the correct balance due, or refund if there is one.
The penalty for filing a return with a balance due late can be stiff. In addition to the interest the penalty is calculated at 5 % per month up to a maximum of 25 % of the tax due with the return.
The penalty for filing a return with a refund due can be even stiffer. There is no interest or penalty due on a return with a refund. However, you only have three years from the due date of the return to file that return to get your refund. If the return is not filed within that time period you can say goodbye to the refund. However, balance due returns still have to be paid even if it’s after three years.
In all of my years of practice I’ve seen many people lose their refunds due to the three year rule. I’ve also had many clients with years where they lost the refund but had balances due on the more recent years. They had to pay those balances without the benefit of being able to use the refunds to offset the balances due.