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What Is a Substitute for Return (SFR)?

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I recently wrote a post about why it’s important for New York bankruptcy debtors to file a tax return even if they can’t afford to pay their taxes. The most important point was that filing a return is crucial even if (and especially if) debtors can’t afford to pay their tax bills, and the penalties for not filing can be substantial. This raises the question, though: How does the IRS know how much debtors owe to calculate the penalties? Certainly some people think the IRS can’t possibly figure it out, but this is a mistake. The IRS receives plenty of information about people’s incomes, and it will file a “substitute for return” (SFR) on their behalves to calculate how much they owe—and how much to penalize them.

The IRS is essentially a giant accounting system, and just like other creditors it can create accounts for collections. The process for creating SFRs is one of them. When the IRS learns that a person has failed to file a return, and it has given that person notice that he or she has not done so, it then prepares an SFR and dedicates an examiner to verify the amount owed.

The examiner goes through multiple documents to attempt to establish the amount owed. Here’s a taste:

W-2 forms filed by employers – This is the mainstay form that shows payroll income, which most taxpayers pay income taxes on. Usually their incomes are withheld automatically from their paychecks to streamline the process for them. The worst case scenario for debtors is that they have under-withheld their paychecks, creating a tax liability that they need to fill.

1099-MISC forms – These are similar to W-2 forms but they are filed by businesses or individuals for the individual contractors they employ.

1099-R – This is a similar form but for pension payments.

1099-SA – This form is similar to the 1099-R, but it applies to Social Security benefits. Yes, the IRS knows how much Social Security people receive.

1099-S –The “S” is for sale of a person’s primary residence. The IRS knows when people make money selling their homes. It’s one way people claim the exclusion of gain from the sale of their primary residences.

1099-C – This is the form generated whenever a creditor cancels a debtor’s debt. Canceled debts are incomes to debtors subject to tax. (For more information, read, “What Form 1099-C Does, and How to Resolve It.”)

With these and other documents it receives, the IRS files an SFR and uses it as the basis for the debtor’s tax liability and penalties. It may be higher than what the debtor earned, but that’s not something worth negotiating. Filing the return beforehand is easier. Conversely, the IRS’s estimate may too low, but that’s not a risk worth taking. The moral is, you can’t escape from the IRS, so file the return.

If you owe tax debts, then it may be may be possible to discharge them in a chapter 7 case or repay them in chapter 13 without interest while discharging older taxes under certain circumstances. To discuss these options, talk to an experienced New York bankruptcy lawyer.

For answers to more questions about tax debts, bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.

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