Dealing with an IRS Substitute for Return? What to Do

unfiled tax

It’s more common than you might think for taxpayers to miss the tax filing deadline. This may happen if you’re worried about paying what you owe, you don’t have your finances organized, or you simply forget and miss the due date.

If you don’t file your tax return on time, it’s possible that the IRS will do it for you. However, this isn’t ideal, as what they file and assess is likely more than you owe. 

Understanding the IRS substitute for return (SFR) is key when you’re wondering how this process works. This post covers all the ins and outs of SFRs and when the IRS would file one on your behalf.

What Is an IRS Substitute for Return?

So, what is an SFR? An SFR is a tax return that the IRS files on your behalf with the information they have on hand. The IRS has the right to file a return for taxpayers in some cases. This may happen if the IRS becomes aware that you are liable for taxes but you haven’t filed or paid even after the IRS contacts you about it via mailed notice. 

Only certain situations trigger this process. Usually, the IRS will learn about your income information from tax forms, such as a W-2 or 1099, from your employer or other payer. Then, the IRS uses that third-party information to create an SFR for you, which will include what you have to pay the IRS to stay in compliance. 

The biggest downside of an SFR—aside from filing late and potentially facing penalties—is that they don’t include any credits or deductions you’re eligible for. So, you will most likely have to pay a much larger tax amount with an SFR than you would if you filed everything properly yourself.

How the SFR Process Works

It’s helpful to break down exactly how the IRS learns about your information, what they do to try to collect, and when they initiate the SFR IRS process. Here’s a step-by-step look:

  • The IRS receives income information about you. 

First, the IRS gathers information about your income for the applicable year through third parties such as employers, clients, banks, etc. If they see there’s no record of your tax return, they’ll send out initial notices.

  • The IRS sends notices.

If you don’t file and the IRS is alerted to your information, they’ll start by sending you a CP59 notice. This document details what you need to do to get your taxes filed and resolve the issue. 

  • You receive a penalty notice.

You may also be hit with the failure to file penalty when you miss the filing deadline. This penalty is equal to 5% of the unpaid taxes you owe for each month your return is late, up to 25%. You could also receive the failure to pay penalty if you also owe taxes, which is 0.5% of your unpaid balance each month, up to 25%.

  • The IRS notifies you of the SFR.

If you ignore the notices and still don’t file your tax return, the IRS will create a notice about an SFR on your behalf. You will receive IRS Notice CP2566 in the mail about the taxes you owe, based on the IRS’s calculations. This balance will also include penalties and interest you have accrued.

  • You have 30 days to resolve the issue with this notice.

At this point, you have a few options to move forward. You can agree to the assessed amount and send in your payment with the enclosed Consent to Assessment and Collection. You can contact the IRS if you believe you’re not required to file a tax return. Or you can file your missing tax return so you can include your credits and deductions.

  • The IRS sends a Notice of Deficiency.

If you don’t do anything within 30 days, you’ll then receive Notice CP3219, also known as the 90-day letter. This notice basically includes the same information about your full tax balance owed and the steps you can take to resolve it. 

You have 90 days to file your tax return or file a petition if you don’t agree with the assessment. If you don’t do anything, the IRS will move forward with the proposed amount they sent you. If you don’t pay the amount assessed, the IRS will start the collection process.

SFR Implications for Taxpayers

So, what does this process mean for you? Essentially, if you don’t file your tax return on time, and the IRS determines that you are required to, you’ll be hit with penalties, notices, and building interest. 

What’s more, if you owe taxes and don’t take action quickly, the IRS will send additional penalties that can add up to create a hefty tax balance. You want to do everything you can to avoid IRS collection actions, which could eventually lead to federal lien filing against you. This means the IRS may seize your property or assets to cover your tax bill. You could also face criminal charges if you’re found to willfully evade or underreport your taxes.

You also may have trouble getting a loan if you have outstanding tax returns. When you apply for a loan, you typically have to provide recent tax returns to lenders. So, if you haven’t filed, this could be a big red flag.

Options for Responding to an SFR

As mentioned, you have a few options when the IRS sends you an SFR notice. Let’s take a deeper look at what you can do:

  • Submit a tax return: This is usually the best option. You will submit a correct tax return that includes all your income as well as deductions and credits you are eligible for. Remember that the IRS doesn’t include these in the SFR, so you could save on your tax bill when you file yourself. You also must file if you want to claim a tax refund.
  • Contact the IRS: If the income on your notice is incorrect or you have questions, you can contact the IRS. Follow the instructions on your notice, or call 866-681-4271. You may also need to contact whoever paid you and submitted the tax forms if the income listed is wrong.
  • Send in your payment and agreement: If the IRS has everything correct and you agree to what they’ve assessed, you also have the option of sending in your signed agreement and paying what you owe. However, remember that you could be missing out on deductions and credits if you go this route.

As soon as you receive an IRS notice, act as quickly as possible. You want to do what you can to avoid additional penalties and interest from building. If you need help filing an overdue tax return or responding to a notice, work with a tax attorney who can assist you.

How to Avoid a Substitute for Return

As with most tax issues, being proactive and following all regulations can help you stay in good standing and avoid an SFR. Incorporate these best practices:

File by the Tax Deadline

The tax deadline is April 15 to submit your return for the prior year. This is also when any tax you owe is due. Put a system in place to remind yourself so you don’t miss this deadline. Remember that if you’re self-employed, you may also need to submit quarterly tax payments by April 15, June 15, September 15, and January 15. 

Keep Organized Tax Records

Many taxpayers fail to follow tax requirements simply because they’re unorganized. They may not have a system in place for tracking income or storing tax documents. This can lead to missed deadlines or inaccuracies when filing. 

Apply for a Filing Extension

If you think you need more time to file your tax return, you can easily apply for an extension. Most extensions are granted by the IRS and give you an extra six months to file. Note that the extension doesn’t apply to paying the taxes you owe—just filing. 

Confirm Accurate Information 

Another best practice is comparing what you report to the IRS with information submitted by employers, financial institutions, or other payers. Promptly inform them if any information is incorrect on your tax forms so they can get the issue resolved. The IRS may have questions if it receives discrepancies in your income information. 

Respond to IRS Notices Before the SFR Stage

Try to respond to any notices right away. This means if you fail to file your return on time, file it as soon as the IRS notifies you that you need to do it. You will probably already have to pay a penalty for being late. But acting quickly ensures you don’t get additional penalties and building interest.

Other Tax Relief Options

If you’re worried about paying your taxes, you have options. It’s always better to be honest with the IRS about your situation and not ignore deadlines and notices. Here are a couple of ways the IRS may help you pay your debt:

  • Installment agreement: Many taxpayers apply for a payment plan when they can’t afford their bill in full. You can pay off what you owe in monthly installments within a set time frame with this option. The IRS makes it easy to apply online.
  • Offer in compromise: You could also try to settle your debt with an offer in compromise. The IRS may agree to allow a lower tax balance if you cannot reasonably afford what you owe. This may require providing financial documents as proof of your finances.

You can also try to appeal any penalties the IRS issues against you or decisions they make about what you owe. When you get a notice, follow the instructions exactly how they’re stated on that notice to submit your appeal and start that process. 

Note the statute of limitations for unfiled tax returns. If you want to claim a refund, you have two years from the date the tax was paid or three years from the return due date to file your return and get your refund. The IRS, however, has 10 years from the date your tax was assessed to collect that tax and any related penalties. If you don’t file a return, there is no statute of limitations on the IRS collecting your tax debt.

An SFR Example Scenario

Let’s walk through a quick example of what could happen with a substitute for return. 

Say Rachel has a regular W-2 job and a 1099 contract position, and she misses the tax deadline in April 2024. She was required to file a return because she received enough income from her employer in 2023. However, she completely forgot to file on time, and she has since ignored notices from the IRS about her failure to file and the associated penalties she’s accruing. 

Finally, Rachel gets IRS Notice CP2566, detailing the taxes she owes on top of the penalties. The IRS used the W-2 and 1099 information it received to calculate her bill. However, it does not include the business expenses she incurred earning the 1099 income, so her tax bill is higher than necessary.

Rachel decides to file a correct return right away so she can take her business deductions and other credits she’s eligible for. Her tax bill ends up being much smaller than the IRS SFR indicated. She submits her payment and files her return, but she still has to pay the penalties and interest she accrued for filing and paying late.

While Rachel was able to resolve the situation by filing on time, she would have completely avoided those penalties and interest charges if she had simply filed by April 15. As a result, she’s out more money, and the IRS had to take the time trying to get her to file.

Avoiding an SFR with Tax Assistance

Filing your tax return on time is critical to avoiding penalties, interest, and trouble with the IRS. When you can’t file on time, apply for an extension. If you have trouble paying your bill, consider a tax relief option. Do what you can to prevent the IRS from filing a tax return on your behalf—a substitute for return. 

If you’re in this situation or you have other tax concerns, work with a tax expert. The team at Seattle Legal Services, PLLC, is here to help you navigate tax law and your tax obligations. Reach out to set up a consultation.

FAQs about IRS SFRs

What is an IRS substitute for return, and why does it matter?

This is a tax return that the IRS will file on your behalf if they receive information about your income but you haven’t filed a return yourself nor responded to notices.

How can I tell if the IRS has filed an SFR for me?

You will receive a notice in the mail about an SFR if the IRS is taking this action. Look for Notice CP2566.

What are my options after receiving an SFR notice from the IRS?

You can file the correct tax return, send in the assessment amount with a signed agreement, or contact the IRS if you believe the information is inaccurate.

Can I dispute an IRS substitute for return?

The IRS will include contact information on your notice so you can alert them to inaccurate information. If you disagree with an IRS penalty, you can appeal their decision and provide your reasoning.

How does filing a late return affect an SFR filed by the IRS?

If you file your tax return within the provided time frame, the IRS will accept that return over the SFR. This allows you to claim tax deductions and credits that weren’t included on the SFR. Remember that you will usually still be responsible for any late filing or payment penalties.

What are the consequences of ignoring an SFR filed by the IRS?

Ignoring an SFR notice means the IRS will move forward with that assessment amount, which is likely higher than what you would have owed filing yourself. You have 90 days from the notice date until the IRS moves forward. If you owe money, the IRS will also begin collections actions.

How can I prevent the IRS from filing an SFR in the future?

File your tax return on time, pay your tax bill, apply for a tax relief option, and keep your records organized. Work with a tax professional if you need tax assistance.

Are there any ways to reduce penalties and interest on an SFR?

You can request first-time penalty abatement in some cases, which will reduce or remove your tax penalties. You qualify if you have a good tax compliance record for the last three years with the same type of return. However, sometimes it’s too late to get this abatement. Ask a tax expert when you’re unsure.

What should I do if I disagree with the tax assessment from an SFR?

If income information is inaccurate, contact the IRS and the payer to let them know. If you want to claim deductions and credits to lower your tax bill, you will need to file your tax return yourself within 90 days of the Notice of Delinquency.

Can an SFR lead to more serious legal actions from the IRS?

If an SFR is assessed and you owe taxes, the IRS could begin collection actions. This means sending additional penalties, building interest, and even filing a federal tax lien. This could lead to asset seizure and other problems.