Tax Anxiety – Good News & Bad News
With the upcoming hype surrounding taxes as April 15th approaches, anxiety increases for those in tax trouble. A significant number of people have been contacted by the taxing authorities about missing tax returns, or are nervously anticipating such contact. Others already have an assessed liability and are facing enforced collection action.
What many individuals who have not filed do not realize is that the problem could be far worse than the possible loss of assets. Both federal and state tax statutes provide for criminal sanctions for not filing tax returns. The IRS can prosecute a delinquent taxpayer under I.R.C. §7203. The state utilizes N.Y. Tax Law §§1802 through 1809. Our recent experience is that the state has been more active in failure to file criminal prosecutions than the federal government.
Even if a delinquent filer is not referred for criminal prosecution, the civil penalties can be devastating. Both the federal and state taxing authorities will assert significant delinquency and late payment penalties up to 25 percent. I.R.C. §6651(a); N.Y. Tax Law §685.
Interest will continuously accrue on the unpaid tax and the penalties, until they are satisfied. I.R.C. §6601(a); N.Y. Tax Law§684.
If the taxing authority discovers that an individual has not filed, a decision is made whether to refer the case to the criminal division or to pursue the matter civilly. If the case stays in the civil arena, demand will be made for the unfiled returns. If the returns are not remitted, Substitute for Returns (“SFRs”) can be prepared. I.R.C. §6020(b).
It is more common for the IRS to prepare SFRs, and the results are usually far less favorable than if the taxpayer prepared the returns.The IRS will utilize the worst filing rates and the taxpayer may not be allowed deductions to which they would otherwise be entitled. The IRS will also share this information with the state. Therefore, the “head in the sand” approach to delinquent taxes is always bad. The good news, however, is that there are useful tools available to assist in reaching a successful resolution of an outstanding tax problem.
Although state tax liabilities are usually more difficult to address, there is one advantage in dealing with the state over the IRS when delinquent returns are involved. New York has a Voluntary Disclosure Program that can be tremendously beneficial to a delinquent taxpayer. N.Y. Tax Law §1700; TSB-M-08(6)I. If one enters the program before being contacted by the state, the request is usually accepted. This eliminates the specter of criminal prosecution and additional time is then given to prepare and submit the tax returns.
It is imperative to move quickly when a client has unfiled state returns, since the program will not be available if the state shows up first. There are cases where the individual and their representative had good intentions and were beginning the process of preparing outstanding returns, but unfortunately, no voluntary disclosure was submitted and the criminal investigation began before the returns were submitted. The prevention of criminal prosecution for a non-filer is a huge benefit in itself. Additionally, the program may allow the taxpayer to file fewer returns than the total number outstanding. Acceptance will also eliminate penalties. Thus, the program can dramatically reduce the economic cost of becoming tax compliant.
Unfortunately, the IRS does not have a voluntary disclosure program for personal income tax matters. Also, penalties will only be waived upon a showing of “reasonable cause” under I.R.C. §6664(c), which is a difficult standard. As a policy, the IRS will normally require serial non-filers to file only the last six years.
The good news with regard to the IRS however is that in May of 2012, the “Fresh Start” Offer in Compromise (“OIC”) Program was initiated, making it much easier for many people with tax debt to settle their liabilities. Additionally, for both State and Federal tax liabilities, bankruptcy, under the right circumstances, can be an extremely useful solution.
However, the benefits of an OIC or bankruptcy are undermined if the tax returns are not filed. Neither the IRS nor the State will consider an OIC if the taxpayers are not tax compliant at the time of the submission. Moreover, even if the tax liability would be otherwise dischargeable as a non-priority tax pursuant to 11 U.S.C. §§507 and 523 of the Bankruptcy Code, liabilities relating to unfiled returns are never dischargeable. With regard to delinquent returns, the liabilities cannot be discharged until two years have elapsed from the date of filing. 11 U.S.C. §523(A)(1)(B)(ii). Therefore, not filing seriously undermines the best options for resolving a large tax liability.
 Generally, a willful failure to file a return, supply information, or pay tax is a misdemeanor under I.R.C. §7203. However, in the case of a willful violation of any provision of section 26 U.S.C. §6050I, the violation is a felony.
 N.Y. Tax Law §1801(1) defines a “tax fraud act” as, “[a person who] fails to make, render, sign, certify, or file any return or report required under this chapter or any regulation promulgated under this chapter within the time required by or under the provisions of this chapter or such regulation[.]”
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