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IRS Substitute Returns: Overstated tax debt that can be solved

Michael S. Anderson Dec. 10, 2011

The IRS substitute tax return is based on the reported gross income...only. It doesn't take into account:

  • mortgage interest

  • children (dependency exemptions)

  • business expenses

  • basis amounts - sale of property and stock

  • charitable contributions

  • marriage situation

  • depreciation

In essence, it doesn't take anything into account that would reduce the tax on the gross reported income. Therefore, the amount is almost always substantially overstated. The IRS knows it is substantially overstated and it is hoping that the threat of such a return will cause the taxpayer to supply the correct return. Unfortunately, many taxpayers don't file on time to beat the ssessment and feel they are stuck with the incorrect assessment amount.

Fortunately, these returns can be "challenged" via the audit reconsideration process. The taxpayer can create a correct return and submit it as a challenge to the substitute return. As a general rule the IRS will replace the incorrect substitute tax return with the more correct taxpayer created return.

I have prepared many actual returns after the substitute return has been assessed, and have often been able to get rid of many thousands of dollars for clients. I recently finalized a return for a client and reduced his debt related to one tax year from $100,000.00 to less than $5000.00. In many cases the reduction results in a refund to the client if the return is filed within 3 years of it's due date.

In most cases, it is best to get the return filed before they do. Doing so preserves the ability to use bankruptcy to discharge the debt later. Where they have beaten you to the punch, there may be a way to correct it in any event. If there isn't... there may be a way to reduce or eliminate the debt.