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Risk of audit after filing delinquent prior year returns

The preparation of delinquent tax returns requires a heightened level of care and accuracy because of the heightened risk of subsequent audit by the taxing authorities. The IRS realizes that many non-filers will not have pristine records from which income and deductions can be determined. A delinquent return that is deemed fraudulent upon subsequent examination by a taxing authority is serious business and will grossly compound a non-filers problems! However, the stated IRS objective of their non-filer strategy is to bring non-filers back into the tax system by securing a substantially correct delinquent return. The focus of IRS non-filer examinations is the non-filer’s tax liability as a whole rather than the considerations of individual income and expense issues. The IRS specifically instructs their agents to pay special attention to Large, Unusual or Questionable Items (LUQs) within delinquent returns. LUQ’s will be deemed appropriate if the non-filer’s responses resolve the examiners’ questions and are consistent with other available information, even if no records are inspected. In-depth review of the non-filer’s books and records should be limited to material items where the non-filer’s responses do not adequately resolve the issue. The agents are also told to look for:

  • 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).
  • A large number of cash transactions (i.e., purchases by cash, cash deposits).
  • Indications of significant unreported income (i.e., substantial interest and dividends earned, investments in IRA accounts, stock and bond transactions, high mortgage interest paid).