Posts Tagged ‘ghost return’

Prepare to pay if you don’t file – Ghost Returns

Posted on: February 15th, 2012 by

Eric L. Bach CPA - Rockville, MDWHEN confronted by a letter from the Internal Revenue Service, some people look at is as though they’ve seen a ghost.  BOO!

And when they open certain letters, a few people do see a ghost — or, more accurately, the ghost of a tax return.

When the IRS detects that a person had reportable income but did not file a return, even after much cajoling, it steps in and does the job itself.  Based on what it knows, the agency prepares what it calls a “substitute for return”, a Form 1040 (the generic tax return).  It lists income, calculates the tax due, adds interest and a penalty for failing to file, and sends the recalcitrant taxpayer a bill based on its efforts.

In one way, that may be a relief to procrastinators who just didn’t get around to filing, perhaps for years.  But it often comes at a VERY high price.

Substitute returns are really no substitute for ones that taxpayers could have filed themselves.  That’s because the IRS uses data from only the income side when it creates such a return, which means that it doesn’t include all kinds of items that might offset that income, according to Julian Block, a tax lawyer in Larchmont, N.Y.

The IRS works from W-2 reports of wages paid, filed by employers, and reports of payments to self-employed people from companies that used their services.  The agency also uses reports from financial institutions about interest and dividends paid and reports from brokers about assets sold.  All these things are taxable income.

For self-employed people, in particular, there is often a big disparity between payments received and taxable income, because much of what they receive goes for supplies or salaries or other expenses.  But the IRS will know only the gross payment, and will plug that figure into its return.  It does not even know about the original cost of assets that were reported sold.

In other words, the IRS does not include many of the deductions to which a non-filer may be entitled.  But this doesn’t mean that the IRS is being mean or vengeful or evil.

The IRS is candid that it does not even look for deductions.  In a fact sheet in what it calls the “tax gap” series on its Web site, the IRS warns that a substitute return it prepares is a “basic” one that “will not include any of your additional exemptions or expenses.”

The IRS investigates about a million “non-filer situations” a year.  But it does not prepare a substitute return for everyone that it believes failed to file.  People in the underground economy do not leave a trail that can contribute to such a return, tax experts have been noted as saying.  If those people are caught, they may not get an official printout in the mail.  A visit from someone who dangles handcuffs from a belt is more likely.  And the IRS substitute is not used when a taxpayer has filed a return but the agency believes that he or she failed to report some income.  It has other methods for resolving those issues — often an audit… just what we all have time for!

A taxpayer prompted to action by a substitute return can file the return that he or she should have filed in the first place, and the IRS will adjust the taxpayer’s account accordingly.  The next step, in which taxpayers can claim their exemptions and deductions, can sharply cut the amount due or even yield a refund.  Many nonfilers wouldn’t owe large amounts if their returns were done properly. The IRS fact sheet says its research shows that such failures “could simply be due to procrastination”, as stated by Mr. Eric Bach, CPA.

ONCE a ghost return appears in the mail, simply avoiding it isn’t a viable option. The IRS will send reminders.  If there is no response, it will start collection efforts, based on its calculations.

“The worst thing a taxpayer can do, is not file a return and then continue to ignore the repeated letters from the IRS”, Mr. Bach said.

But taxpayers sometimes do just that, provoked by “fear, paralysis, and denial”, as Mr. Bach has stated it.  “The most important point to remember is that the substitute returns only reflect the income and some some expense information such as mortgage interest because they are required to be reported to the IRS.  These returns are not final.  When the actual return is filed, it supercedes the ‘ghost return’.  This is very important to remember because the actual return will include your itemized deductions that may substantially reduce the IRS’ original assessment.”  In essence, Mr. Bach’s point is, file your returns as quickly as possible if a “ghost return” has been filed to, not only reduce your tax debt and possibly eliminate it, but also to minimize penalties.

Unpleasant as it may be to file  a tax return, and paying the bill to begin with… filing may prove much more appealing than the alternatives.