This Halloween, Beware the Ghost Tax Return

October 18, 2013
Disney Ghost

At Halloween, ghosts can be great fun without being scary. But a “ghost tax return” prepared by the IRS can haunt taxpayers for years if they don’t respond quickly to IRS notices.

Many taxpayers are afraid of getting a notice from the Internal Revenue Service (IRS). But some of them can be forgiven if they look as if they’ve seen a ghost when an unexpected IRS notice arrives – because what they’re seeing is a ghost tax return.

What’s a ghost tax return? Luckily, it’s something that most taxpayers will never see. A ghost tax return is what the IRS calls a “substitute for a return”.  The only taxpayers who will ever see one are those the IRS had decided had reportable income, but didn’t file a return after several reminders.  So the agency prepares a ghost tax return.

The taxpayer receives:

  • Form 1040 that lists the income reported to the IRS, and calculates the tax due.
  • A demand for payment of the taxes that are due on the reported income plus added interest and penalties for failure to file the required return and make payment on time.

There’s no reason to fear a ghost tax return. All you have to do to avoid this kind of haunting sight is file your tax returns on time.

Costly Procrastination

In case you’re among those who hate to file tax returns, don’t be tempted to let the IRS do it for you by preparing a ghost return on your behalf. The “convenience” comes at a high price, because the IRS uses only the income reported on a Form W-2, K-1, or 1099, plus any interest and dividends paid to the taxpayer by a financial institution or any assets sold. Ghost returns don’t consider any factors that might reduce the amount owed.

Now that nearly all taxable payments are reported electronically to the IRA, it’s easier and faster for the agency to identify taxpayers who aren’t filing returns. And that can be especially costly to small business owners and self-employed people.

“There can be a big difference between payments received and taxable income,” says Brendon Pack, a Vice President at 1-800Accountant.  “They may be billing a client for supplies or other expenses. But the IRS has no way of knowing that, so they will simply plug the gross payment into the return it prepares.”

It’s also costly for taxpayers who sell assets such as a house, stocks or bonds. “The IRS won’t know the original cost of the asset that was sold, and whether it qualifies as a capital gain or is ordinary income,” Pack adds.

And, of course, the IRS doesn’t have any way to know about any deductions a taxpayer could have taken if they had prepared the return themselves or with the help of a tax preparer. “Deductions matter. And if a tax return is based only on income, it’s going to result in a much higher tax bill than one that includes even the most basic deductions such as those for dependents, or a home mortgage,” he said.

The IRS says that it investigates about a million situations every year where it receives a notice of taxable income that can’t be matched to a tax return. But not all of those will result in a “substitute for return”. Some will get a visit from a law enforcement officer with handcuffs instead, and others won’t result in any action at all because the IRS can’t identify the taxpayer who should have filed.


What to Do if You See a Ghost (Return)

If you are among those taxpayers who do attract the attention of the IRS with a ghost return, you can file the past-due return yourself, and ask the IRS to adjust your account. By filing a return that’s late, but correct, you may still face penalties or interest, but nearly all non-filers can save money with a proper tax return instead of a substitute prepared by the IRS.

Sometimes taxpayers are even due a refund, but there is a statute of limitations on IRS refunds, so refunds will only be given on returns filed within three years from the date that the return was originally due.

The worst thing a taxpayer who gets a ghost return from the IRS can do is to try to run away or ignore the notice. Not responding with an amended return and payment can result in a range of collection activities including:

  • Frozen bank accounts
  • Liens on houses and other tangible property
  • A levy on paychecks
  • Notices to customers to send payments owed to a self-employed person to the IRS instead

Don’t let things get that far. If you failed to file because you didn’t think your income met the threshold, talk to a tax advisor and file as soon as possible. No matter what the reason your return wasn’t filed, if you receive any kind of notice from the IRS, pay attention to it and respond as soon as you can.

Photo credit: Madame Carlotta, the ghostly greeter from Walt Disney World’s Haunted Mansion ride, was photographed by Deb McAlister-Holland in October, 2011. Used with permission; all other rights reserved.
Talk to an Accountant