The IRS continues to enhance its ongoing enforcement efforts and expedited reporting between the IRS and the state taxing agencies will have a significant future impact on taxpayers who, for whatever reason, have failed to timely file their tax returns. The government can better identify taxpayers who have underreported or not reported income or have otherwise failed to file returns. As a result, hunting for non-filers will likely become the trophy sport for the IRS!
Non-Filers. A “non-filer” is a taxpayer (or someone who the government believes ought to be a taxpayer) who does not file their return before the deadline to file the next year’s return. A “late filer” is taxpayer who misses the deadline for the year in question, but files the return within the following year. Many non-filers analyze optional strategies given the probability of audit and detection and the extent of penalties, if discovered. Others claim to be trapped into non-filing status because of past decisions. Typically, non-filers fall into three categories:
i) Procrastinators – Know they should file but need assistance and/or prompting. They will typically respond and always indicate that they will cooperate. However, information is generally slowly provided in a piecemeal fashion.
ii) Uncooperative Non-Filers – They refuse to acknowledge and respond to correspondence and/or phone calls and state up front that they will not cooperate.
iii) Tax Protestors – Advocate and/or use tax protestor’s schemes (i.e. refusal to file because of alleged constitutional reasons).
The IRS has identified at least 10 million delinquent returns and is pursuing a cross-functional National Non-Filer Strategy to identify non-compliant taxpayers and design methods to encourage their compliance. Before contacting a non-filer, the IRS will often attempt to identify the non-filer’s occupation, location of bank/savings accounts, sources of income, age, current address, last file returned, adjusted gross income of last file returned, taxes paid on last file returned – amounts and methods of payment (withholding, estimated tax, pre-payments), number of years delinquent, and the non-filer’s standard of living. They will search public records for evidence of additional unreported income, tax assessor and real estate records for assets held by the non-filer, and records of professional associations and business license bureaus for information on businesses being operated by the non-filer. They will also search various state records to disclose corporate charter information including principals of any businesses that have failed to file returns.
Determining the specific occupation of the non-filer can lead to additional sources of information, such as labor unions, professional societies, trade associations, etc.. IRS will also determine whether there is a history of non-filing (multiple non-filed years provide a pattern of behavior), whether there have been repeated contacts by the IRS, indications that the non-filer had knowledge of filing requirements (i.e. professional with an advanced education, person who works directly in the tax field), whether there are a large number of cash transactions (i.e. purchases by cash, cash deposits as evidenced by currency transaction reports, etc.) and whether there are indications of significant unreported income (i.e. substantial interests and dividends earned, investments in IRA accounts, stock and bond transactions, high mortgage interest paid, etc.).
If a non-filer is contacted by the government, the examiner will determine the cause (does the non-filer lack records, ability to pay, lack of education, etc.) and may offer necessary information or assistance (preparation of returns, payment arrangement information, etc.) to secure full cooperation. If the non-filer is uncooperative (won’t respond or refuses to cooperate), third party contacts and Summonses will be issued. If the examiner discovers subsequent acts of tax evasion (false statements, refusal to make records available, etc.), they will consider whether the case should be referred for a criminal investigation. The examiner will also be alert to attempts by the non-filer to conceal or transfer assets to evade collection of tax later assessed. In these cases, a jeopardy (immediate) assessment may be considered.
During non-filer examinations, the examiner will determine if related returns (corporate, partnership, employment tax, and excise tax returns) have been filed as required. They will also search for spin-off cases involving relatives, employees, employers, subcontractors, partners, and even return preparers! If a non-filer is involved in a family business, the examiner should determine if all family members have filed returns. If the non-filer is involved in a partnership, the IRS should determine if partnership returns have been filed and determine if all partners have filed returns. For delinquent corporate returns, they should determine if all shareholders have filed returns.
The IRS may independently prepare a tax return and the related assessments under Internal Revenue Code § 6020 (b). These assessments are generally based on very limited information, such as that gathered from Forms W-2 and 1099. For these cases, IRS assesses the maximum potential tax owed based on gross receipts since they don’t have access to potential deductions, exemptions or credits available to the taxpayer. By failing to file a return, a taxpayer may also lose a refund of any amounts withheld. The failure to file and pay self-employment tax by self-employed individuals could cause them to be ineligible for social security retirement or disability benefits.
The role of IRS Criminal Investigation (IRS-CI) in the National Non-Filer Strategy is generally the enforcement of the tax laws for individuals who are not responsive to outreach efforts. IRS-CI has developed and investigates high impact investigations of non-filers in various occupations and industries, as well as those who file non-processable returns or employ frivolous arguments which the courts have repeatedly rejected. The majority of people who come forward and file returns prior to being notified by IRS are not pursued through a criminal investigation. However, a non-filer should not wait since the “first knock on the door” may be that of a special agent from IRS-CI.
Voluntary Disclosure. Practitioners often struggle with the issue of whether a taxpayer can avoid a criminal tax investigation by making a disclosure to the IRS. A “voluntary disclosure” is generally the process of voluntarily reporting previously undisclosed income (or false deductions) through an amended return or the filing of a delinquent return. A taxpayer’s timely, voluntary disclosure of a significant unreported tax liability is an important factor to the IRS in considering whether the matter should be referred to the U.S. Department of Justice for criminal prosecution. Properly resolving this issue can mean the difference between a taxpayer being criminally excused of a tax crime or being convicted on the basis of admissions derived from the voluntary disclosure itself.
Certainly, the IRS has a somewhat limited capacity to perform criminal investigations. However, a significant amount of time is not required to criminally investigate and prosecute a non-filer, particularly one who files delinquent or amended returns following an IRS inquiry. Without adequate representation, the perceived light at the other end of the voluntary disclosure tunnel….may be the IRS train coming straight at the taxpayer!
The IRS voluntary disclosure policy creates no substantive or procedural rights for taxpayers, but rather is a matter of internal IRS practice, provided solely for internal guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution. A timely voluntary disclosure will not guarantee immunity from criminal prosecution, but a true voluntary disclosure will normally result in the IRS not even recommending a criminal prosecution to the Department of Justice.
A voluntary disclosure must be truthful, timely and complete, and the taxpayer must demonstrate a willingness to cooperate (and must in fact cooperate) with the IRS in determining the correct tax liability. The taxpayer must make good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. Additionally, the policy only applies to income earned through a legal business – – so called “legal source” income.
To be timely, the disclosure must be received before: (i) the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation; (ii) the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance; (iii) the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or (iv) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
A voluntary disclosure does not occur until IRS has actually been contacted. As such, it is imperative that the disclosure occur as quickly as possible. A voluntary disclosure cannot be made anonymously. Any plan by a taxpayer, or their representative, to resolve a tax liability, file a correct return, or offer payment of taxes for an anonymous client is not to be considered a voluntary disclosure. IRS will rarely recommend prosecution if there has been a timely voluntary disclosure. Since returns filed pursuant to a timely voluntary disclosure have significant audit potential, they should be “bulletproof” in correctly reflecting the taxpayer’s income and expense items. Due to various federal-state information sharing agreements, any applicable state returns should obviously be contemporaneously filed or amended with the federal returns. Returns for related entities should also be contemporaneously filed or amended. If a return filed pursuant to a voluntary disclosure is less than accurate, the taxpayer is compounding – – not helping the problem.
How many returns must be filed or amended? While there is certainly no well-established rule as to how many returns must be filed in making a voluntary disclosure, the general consensus is probably six tax years since the applicable statute of limitations for most tax related crimes is six years. The disclosure should eliminate any government concern that there might be any potential issues with respect to a particular tax year for which the applicable statute of limitations for criminal prosecutions has not already expired. Additional returns could be in order since the statute of limitations for a criminal prosecution is tolled for the period of time a taxpayer is outside of the United States or is a fugitive from justice.
Typically, in a civil context, it is also the IRS policy to enforce the filing of returns for the prior 6 tax years. In considering whether shorter or longer periods should be civilly enforced, the IRS will determine the prior history of non-compliance, the possible existence of income from illegal sources, the effect on voluntary compliance, the anticipated revenue in relation to the time and effort required to determine the tax due, and special circumstances existing in the case of a particular taxpayer, class of taxpayer, or industry, which may be particular to the class of tax involved. The objective of the National Non-Filer Strategy is to bring non-filers back into the tax system by securing a substantially correct delinquent return.
Counsel must determine whether to contact the IRS before submitting a voluntary disclosure and actually filing the delinquent or amended tax returns. Some practitioners prefer to submit a Freedom of Information Act (FOIA) request seeking income information already in the possession of the IRS before filing the returns. Some simply choose to file the delinquent or amended returns, with payment, with the appropriate IRS service center (now referred to as a “campus”) by certified mail, return receipt requested. Filings are often sent in separately for each tax year spaced out over a brief time period. Such filings occur during the typical tax return filing season – around April 15 and October 15 for individual returns. When you run with the bulls….
“Do The Right Thing.” Tax laws cannot be administered by solely relying on enforcement because the government simply does not have resources to react after-the-fact to compliance concerns. Instead, taxpayers must be educated about their obligations and encouraged to “do the right thing.” Complex tax rules tend to be the oil fields into which the “perennial loophole seekers punch holes looking for a gusher.” The best strategy is full compliance with the filing and reporting requirements…don’t wait to find a stranger knocking on the door!