- Initial Contact by Non-Filer: There are many different factual situations that can cause a non-filer to contact an accountant for assistance in preparing delinquent tax returns. We will examine the following:
- Voluntary filing before any contact by the IRS.
- Filing after contact by the Substitute for Return Section.
- Contact by a Revenue Officer or Revenue Agent.
- Issuance of a summons to the taxpayer by the IRS.
- Contact by a Special Agent of the IRS.
- General Rules: In all situations where the taxpayer has contacted you concerning the filing of delinquent tax returns, the following rules should be followed:
- Do not give advice over the telephone.
- Make an appointment and have the taxpayer come to your office for a meeting.
- Take control of the meeting from the beginning.
- Before the taxpayer reveals any facts as to why he has not filed tax returns:
- Explain to the taxpayer that failure to file is a crime.
- Explain to the taxpayer that the taxpayer can be prosecuted and possibly sent to prison for failing to file tax returns.
- Do not ask questions regarding the taxpayer’s reasons for not filing or anything about the amount of his taxable income or deductions.
- Do not prepare and file tax returns.
- The taxpayer should not tell you any facts as to why returns have not been filed, since there is no privilege between you and the taxpayer, and you could become a witness against the taxpayer.
- Advise the taxpayer to contact an attorney before telling you anything about why returns have not been filed. By engaging a tax attorney, the taxpayer permits the attorney to enter into a three-party agreement whereby the taxpayer and the attorney hire you to assist the attorney in analyzing the accounting facts and returns to be prepared in defense of the IRS tax fraud investigation.
- If the taxpayer desires to contact an attorney, then arrange for the taxpayer to contact an attorney who is experienced in criminal tax matters.
- If the taxpayer elects not to contact an attorney, then make sure the taxpayer understands that anything he tells you is not protected by any privilege, and that you could be required to testify against him if he is ever investigated by the IRS for failure to file tax returns.
- Immediately instruct the taxpayer not to discuss the matter with anyone. Advise the taxpayer not to talk to the IRS under any circumstances.
- If the taxpayer continues to proceed without the advice of an attorney, then make detailed notes for your file as to what you told the taxpayer and consider giving the taxpayer a letter that states something similar to the following:
You have contacted this firm concerning the preparation of tax returns which have not been filed. We have advised you that failure to file tax returns is a crime and that you should seek legal advice concerning this matter. We have advised you that before you reveal any facts concerning these tax returns, you should seek legal advice. You have decided to proceed with this firm preparing these tax returns without first contacting an attorney.
- The purpose of this letter is to protect you from a future claim by the taxpayer that he was not advised to seek legal advice before telling you all the facts as to why he has not filed.
- In many cases the taxpayer will not want to seek legal advice, and in many cases the taxpayer will not need legal advice. However, in order to protect you, the above advice should be given before learning anything about the taxpayer or his situation.
- Why the Above Rules Should be Followed
- To protect yourself from becoming the government’s primary witness against the taxpayer in criminal and/or civil fraud cases, and to protect you from testifying regarding the taxpayer’s “confession” to a violation of any of the criminal tax laws.
- IRS Special Agents will always contact the tax return preparer in a criminal case to determine what the preparer was told and given.
- The MOST IMPORTANT thing is that the taxpayer complete and file accurate tax returns before being contacted by the IRS.
ll. VOLUNTARY FILING BEFORE ANY CONTACT BY THE IRS
A taxpayer may contact you to file delinquent returns for several years prior to any contact or investigation by the IRS. Where the IRS has not contacted the taxpayer, the taxpayer has the following options in filing the delinquent tax returns:
- Preparing Tax Returns Without an Attorney
- Follow the general rules set forth above.
- It is imperative to prepare these returns as rapidly as possible to avoid IRS discovery of the delinquency before the voluntary disclosure is made. Also, the preparation and related analysis is essential for understanding the dollar amount of tax liability involved, which will have a direct bearing on whether the IRS will initiate criminal prosecution.
- Obtain as much data from the taxpayer as possible in order to assure that complete and accurate tax returns are prepared.
- Learn as little as possible about why the taxpayer failed to timely file tax returns. Concentrate on preparing complete and correct tax returns.
- If at anytime you believe the taxpayer is not being completely honest, or something comes to your attention that could cause the taxpayer criminal problems, then you should stop all work and insist that the taxpayer seek legal advice.
- Consider that this is truly a voluntary disclosure under present IRS guidelines.
- Determine how many years of delinquency are involved. While you have the obligation to advise the taxpayer to file all delinquent tax returns, an attorney may not have the same obligation. Further, the IRS policy in delinquent tax return matters is to secure only the last six years of tax returns. See Policy Statement P-5-133. However, it may not be possible to prepare six years of tax returns. Only prepare tax returns that are correct and audit proof. This may mean only one year can be prepared.
- Many advisors recommend that the taxpayer file the delinquent returns, without any explanation, directly with the IRS, and do so in a staggered fashion (i.e., one return every other day or so).
- CPAs, enrolled agents, and tax attorneys who have filed directly with the Campus have informally reported, with few exceptions, that the IRS accepted the returns as filed. The IRS generally has sent a bill for interest and failure to pay and failure to file penalties following the delinquent filings.
- Civil examination of the returns may or may not be commenced by the IRS. However, after the taxpayer files delinquent returns, the IRS Examination Division may assert the negligence penalty; and, if the case is flagrant, may assert the fraud penalty. A 90-day letter or a waiver of assessment is necessary prior to IRS assessment of these penalties.
- In preparing the tax returns, resolve all questionable items of any type in favor of the IRS. This may cause the taxpayer to pay more in taxes, but will protect the taxpayer from fraud allegations in the future.
- After the tax returns are prepared they should be mailed in separate envelopes to the Service Center, certified mail, return receipt requested. A cover letter containing something similar to the following should accompany each tax return:
Certified Mail #P 123 456 789
Return Receipt Requested
Internal Revenue Service
Austin, Texas 73301
Re: John Doe – SSN 555-55-555
Enclosed are the original and one copy of the taxpayer’s tax return for 1988, and an extra copy of this letter.
Please stamp the enclosed copy of this letter and the extra copy of the 1988 tax return indicating that they have been received, and return them to us in the enclosed stamped self-addressed envelope.
The purpose of this letter is to establish that the return was sent and received by the IRS. The reason to send the returns in separate envelopes is two-fold: First, it is impossible for the IRS to process more than one item that comes in the same envelope; and secondly, there is no reason to alert the IRS that the taxpayer has not filed a number of tax returns by placing them in the same envelope. As a practical matter, the Service Center reviews all delinquent tax returns.
- Preparing Tax Returns With an Attorney
- Follow the general rules set forth above.
- The tax attorney will engage you for preparation of the delinquent tax returns as distinguished from you working directly for the taxpayer in preparation of the returns. The attorney, taxpayer, and you will enter into a three-party agreement setting forth these facts and other facts that are necessary to place you under the attorney-client privilege. This three-party agreement places the persons preparing the returns under the attorney-client privilege with respect to anything not disclosed on the returns.
- Follow the same steps as when preparing tax returns without an attorney set forth above.
- Making a Voluntary Disclosure to CI
- The taxpayer must retain an attorney in this situation. The attorney will contact Criminal Investigation (hereinafter “CI”) and meet with CI to make a voluntary disclosure.
- Determine how many years’ returns must be prepared. Under the IRS voluntary disclosure policy, the taxpayer may be required, as a minimum, to prepare all returns within the six-year statute of limitations period that is open for criminal prosecution. Additionally, the IRS may require complete return preparation for earlier years if possible.
- The attorney may explore (based upon a hypothetical situation) with CI whether the IRS will consider the case as a voluntary disclosure case.
- If CI is willing to consider the case a voluntary disclosure, then the attorney will arrange for preparation and filing of the returns (prepared by you under a three-party agreement) directly with CI (through the attorney). The attorney will meet with CI, and present the facts surrounding the taxpayer. If CI indicates that a voluntary disclosure will be considered, then the attorney for the taxpayer must reveal the name of the taxpayer. No CI decision will be made at this conference as to whether the case will be accepted as a voluntary disclosure matter.
- The IRS will check to determine whether any investigation is open on this taxpayer in other IRS divisions or districts, or if there has been a “triggering event” that has caused the taxpayer to come forward to disclose the delinquent returns.
- If the IRS accepts the case as a voluntary disclosure matter, CI will deliver the returns and tax payments, if any, to the Chief, Collection Division, for processing and will notify the taxpayer’s attorney of such acceptance.
- Contact by a Revenue Officer: In this situation, the IRS knows the taxpayer has not filed tax returns, and this will never be considered a voluntary disclosure. As set forth above, there is a definite procedure that the Revenue Officer will follow. Experience shows that even when a taxpayer has been contacted by a Revenue Officer and the tax returns are prepared and filed, the taxpayer is not prosecuted. Of course no one can assure the taxpayer that this will not happen; however, it is generally in the most flagrant cases and where the taxpayer refuses to file that the taxpayer would be subjected to prosecution.
- Follow the general rules set forth above.
- If a tax attorney has been engaged the tax attorney will retain you for preparation of the delinquent tax returns as distinguished from the you working directly for the taxpayer in preparation of the returns. The attorney, taxpayer, and you will enter into a three-party agreement setting forth these facts, and other facts that are necessary to place you under the attorney-client privilege. This three-party agreement places the persons preparing the returns under the attorney-client privilege with respect to anything not disclosed on the returns.
- The taxpayer should not respond to any questionnaires or other requests for information from the Revenue Officer. Never, never should the taxpayer submit to an interview with the IRS when tax returns have not been filed.
- Try and prepare the tax returns within the time frame set in the letter that is received. If necessary, call the Revenue Officer and ask for an extension to file the returns. However, an extension probably will not be given. In that case, try and prepare as many and at least one return before the due date. When transmitted, advise the IRS that the other returns will be sent shortly. In most cases, when the Revenue Officer realizes that the taxpayer is going to get the returns filed and the returns are filed as quickly as possible, the Revenue Officer will give the taxpayer additional time to file the returns. Also, when initially speaking with the Revenue Officer, ask if this is a criminal matter. The IRS probably will not tell you, but if they do, then urge the taxpayer to seek legal advice, if the taxpayer has not already done so.
- This will not be considered a voluntary disclosure.
- Determine how many years of delinquency are involved. The IRS will request returns for particular years, and these are the returns that should be prepared.
- Civil examination of the returns may be done, but experience shows that rarely, if ever, do tax returns get audited when the returns have been requested by a Revenue Officer.
- After the returns are prepared they can either be given to the Revenue Officer or mailed in separate envelopes to the Service Center, certified mail, return receipt requested. If the returns are delivered to the Revenue Officer, then the Revenue Officer will make an immediate assessment and begin the collection process. If the returns are mailed to the Service Center, then the returns will be processed through normal procedure and it will be several months before the account is assigned to a Revenue Officer for collection. There is no correct answer in this situation, and it depends on the facts. If the returns are sent to the Service Center, then copies should be sent to the Revenue Officer who originally requested the returns. A cover letter containing something similar to the one in paragraph M above should be used.
- The purpose of this letter is to establish that the returns were sent and received by the IRS. The reason to send them in separate envelopes is two-fold: First, it is impossible for the IRS to process more than one item that comes in the same envelope; and secondly, there is no reason to alert the IRS that the taxpayer has not filed a number of returns by placing them in the same envelope. As a practical matter, the Service Center reviews all delinquent tax returns.
lll. ATTACHING RIDERS TO RETURNS
There may be certain situations which require disclosure on taxpayers’ returns in order to fully apprise the IRS of the nature of the transaction and the position taken. There are no hard and fast rules to determine when such disclosures are necessary. However, generally when full disclosure is made in connection with the preparation of a return, no criminal activity can be alleged against either the taxpayer or the preparer. It is wise to attach a rider to a return any time it is felt that failure to disclose might be an indication of attempting to conceal, mislead or commit fraud against the IRS.
Anytime a taxpayer does not have perfect records and you are preparing a delinquent tax return, you should consider attaching an appropriate rider to the return. The rider will state what records were relied upon and the fact that they were not complete. An example of such a rider is as follows:
ATTACHMENT TO FORM 1040
This tax return was prepared from various information available to the taxpayer including but not limited to bank statements, summaries, estimates, and other data. Taxpayer has attempted to furnish accurate and complete information to his tax return preparer so that a complete and accurate tax return could be prepared. Should taxpayer discover additional information which would change any of the figures or information on this tax return, taxpayer will file an amended tax return.
There are two schools of thought on whether to compute penalties and show them on a delinquent return at the time the return is filed, or not to compute any penalties and to wait and see if the IRS assesses penalties. The best approach seems to be to let the IRS determine what penalties will be assessed, and then challenge these penalties if appropriate.
V. SEPARATE vs. JOINT TAX RETURNS
When preparing delinquent returns, the preparer must consider whether to prepare separate or joint returns. Generally, it is best to prepare separate rather than joint returns. First, if the taxpayers have separate property, their separate property will not be liable for the separate tax debt of the spouse that does not have separate property. Secondly, if penalties are assessed, it may be possible to have the penalties abated against one spouse when separate returns are filed. Generally, one spouse may have a good valid reason for failing to timely file returns, and in that case the IRS may abate the penalties.
Need assistance in managing the audit process? Freeman Law’s team of attorneys and dual-credentialed attorney-CPAs regularly represents taxpayers before the IRS and Texas Comptroller. Our team also provides tax return-related representations and helps taxpayers navigate state tax laws. Our Firm offers value-driven services and provides practical solutions to complex issues. Schedule a consultation or call (214) 984-3000 to discuss our tax representation services.