The Ghost Tax Return: What happens when you don't file a return.

An unexpected letter from the I.R.S. (that does not include a refund check), will make  some people look as though they’ve seen a ghost. And when they open certain letters, a few people do see a ghost — or, more accurately, the ghost of a tax return.

When the I.R.S. detects that a person had reportable income but did not file a return — even after much cajoling and many letters — it steps in and does the job itself. Based on what it knows, the agency prepares what it calls a “substitute for return” — or SFR . It lists income, calculates the tax due, adds interest and a penalty for failing to file, and sends the tardy taxpayer a bill based on its efforts.

Before you think the I.R.S. has saved you some tax preparation fees, think again.

SFRs  are really no substitute for the ones that taxpayers could have filed themselves.   That’s because the I.R.S. uses data from only the income side when it creates such a return, which means that it doesn’t include all kinds of items that might offset that income, such as marital status, exemptions for children, deductions, such as mortgage interest or business expenses, credits for education.

Where does the I.R.S. get it’s information?  From the employers who gave you a W-2, or  1099’s sent to the self-employed.   The agency also uses reports from your bank reporting interest they paid you on a savings account.

For self-employed people, in particular, there is often a big difference between the payments you received from work and the actual  taxable income, because much of what you make  goes right back out to pay for supplies  or other business expenses expenses. But the I.R.S. doesn’t know that, and  will  only put  the gross income on your return.

In other words, the I.R.S. does not include any of the deductions to which you may be entitled.

The SFR is the IRS’s  move of last resort and is prepared only after sending the taxpayer several letters saying it has no record of a return for a given year.  Typically, the return will not be prepared for at least a year after those letters start arriving, and only after the I.R.S.’s patience has worn out.  So, don’t think that because a year or two has gone by you have beat the system.  They will not forget you!

A taxpayer who received notice that an SFR return has been filed, can  file the return that he or she should have filed in the first place, and the I.R.S. will adjust the taxpayer’s account accordingly.  That step, in which taxpayers can claim their exemptions and deductions, can sharply cut the amount due or even yield a refund.

But even if a return calls for a refund, it won’t be paid if the return is filed more than three years after it was due, because of a statute of limitations.

Enforcement efforts against people who don’t respond are quite straightforward.. Typically, the agency will put a levy on an employed person’s paychecks, taking a chunk from each one until the bill is paid. It may direct a company that pays a self-employed person to send the money directly to the government. It can also freeze bank accounts and put liens on homes.

Unpleasant though it may be, filing a tax return — and paying the bill to begin with — may prove much more appealing than those alternatives.