Non-Filers Beware: Who’s That Knocking at Your Door ?

For numerous reasons, many taxpayers fail to timely file required U.S. income tax returns and associated reports. A “non-filer” is described as a taxpayer (or someone who 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 when contacted by the IRS.  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 if contacted by the IRS clearly state 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 has been 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 sales tax returns and the state records to disclose corporate charter information including principals of any businesses that have failed to file returns. They will contact the last known employer to determine if the non-filer is still employed and the specific occupation of the non-filer.
Determining the specific occupation of the non-filer can lead to additional sources, such as labor unions, professional societies, trade associations, etc. The 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.).
Tax Evasion and Fraud? 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 not cooperative (won’t respond or refuses to cooperate), third party contacts may be made to determine the non-filer’s income and make an assessment.
When contacting the taxpayer, the IRS will attempt to gather as much information as possible to arrive at a substantially correct tax assessment.  They will also attempt to establish reasons for the non-filing by asking specific and direct questions (i.e. Why were returns not filed?  Did you know that you were required to file returns?).
If the examiner discovers subsequent acts of tax evasion (false statements, refusal to make records available, etc.), they will often 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.
The manner in which responses occur could dictate the future course of action by the IRS examiner (i.e., whether to pursue penalties and/or a referral for criminal investigation). Willful failure to file a tax return is a misdemeanor pursuant to IRC 7203. In cases where an overt act of evasion occurred, willful failure to file may be elevated to a felony under IRC 7201. If failure to file a return is fraudulent, a civil penalty known as the “fraudulent failure to file (FFTF) penalty” may apply under IRC 6651. The mere fact of failing to file a return does not constitute sufficient evidence to sustain fraud. Overt acts of evasion must be identified.
On the initial screening of a non-filer case, the IRS will attempt to determine if the facts indicate potential fraud. Indicators of fraud for consideration include:

• History of non-filing or late filing, and an apparent ability to pay;
• Repeated contacts by the Service;
• Knowledge of the filing requirements (i.e., advanced education, business (especially tax) experience, record of previous filing etc.);
• Experience of the taxpayer in tax matters such as a law professor, CPA or tax attorney;
• Failure to reveal or attempts to conceal assets;
• Age, health, and occupation of the taxpayer;
• Substantial tax liability after withholding credits and estimated tax payments;
• Large number of cash transactions, i.e., purchases by cash and large cash deposits evidenced by documented cash transactions, payment of personal and business expenses in cash when cash payment is unusual and/or the cashing (as opposed to the deposit) of business receipts;
• Indications of significant income per Information Return Processing (IRP) documents (i.e., substantial interest and dividends earned, investments in IRA accounts, stock and bond transactions, high mortgage interest paid);
• Refusal or inability to explain the failure to file; and
• Prior history of criminal tax prosecutions for Title 26 violations.

If the IRS believes the possibility of fraud exists, the IRS Internal Revenue Manual provides that they should:

1. DO NOT SOLICIT tax returns. If returns are submitted, they should be accepted but not processed, and clearly documented in the case history.
2. DO NOT VOLUNTEER ADVICE to the taxpayer concerning any potential course of action to follow.
3. DO NOT DISCUSS tax liabilities, penalties, fraud, or criminal referral possibilities with the taxpayer.

During non-filer examinations, the IRS 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 will determine if all family members have filed returns.  If the non-filer is involved in a partnership, the IRS will determine if partnership returns have been filed and determine if all partners have filed returns.  For delinquent corporate returns, they will attempt to determine if all shareholders have filed returns. Penalties are not typically be easily waived in non-filer cases without reasonable cause.
During the non-filer examination, the IRS will likely:

1. Interview the taxpayer to determine the reason or the intent of the taxpayer’s noncompliance.
2. Ask sufficient questions to determine the extent of the delinquency, including the periods and tax due.
3. Document verbatim, if possible, the questions asked and the taxpayer’s response or lack of response.
4. Identify any personal reasons that could affect the taxpayer’s ability to comply. If the information is not provided by the taxpayer, attempt to secure the information from third party sources.
5. Attempt to get a definitive statement from the taxpayer regarding additional expenses not listed in the books and records. These expenses could include, but are not limited to, expenses paid in cash or “under-the-table” payments to employees.
6. Attempt to establish year-end cash on hand for each year under investigation.

The role of IRS Criminal Investigation (IRS-CI) in the IRS non-filer strategy is the enforcement of the tax laws for individuals who are not responsive to outreach efforts. IRS-CI has historically devoted resources to identify these individuals, and in the more flagrant cases, criminal prosecution has been and will continue to be recommended. 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.
Substitute for a Return. If the taxpayer does not respond to government inquiries, 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.
What to do? 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.
Generally, people who come forward and file returns prior to being contacted by IRS are not pursued through a criminal investigation, might be able to reduce or eliminate potential civil penalties, and may be able to coordinate an effective installment payment arrangement (or Offer in Compromise) for any resulting deficiencies. Regardless, a non-filer should not wait since the “first knock on the door” may be that of a special agent from IRS-CI.
Counsel should likely determine whether to contact the IRS before submission of a voluntary disclosure and should be consulted before actually filing the delinquent or amended tax returns.  If not properly coordinated (or not timely), submission of amended or delinquent returns might be deemed an important admission in a later criminal proceeding. If timely and submitted in accordance with the IRM, a timely voluntary disclosure can avoid a criminal referral and may significantly reduce or possibly eliminate the imposition of civil penalties on any resulting tax deficiency.
 http://taxlitigator.me/2014/09/08/non-filers-beware-whos-that-knocking-at-your-door-2/