When the IRS Prepares Your Business Return: 6020(b) and Letter 1085

Most people know the IRS can prepare a substitute for return for an individual who does not file. Fewer know that a Revenue Officer can prepare a business's payroll, excise, and partnership returns, sign them, and send them in for assessment. For a business owner behind on filings, that is often how the problem becomes a debt.

The authority

IRC 6020(b)(1) says that if any person fails to make a required return, the IRS "shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise." Under IRC 6020(b)(2), a return so made and subscribed is "prima facie good and sufficient for all legal purposes."

For field collection, IRM 5.1.11.7.7 lists the business returns that Revenue Officers may prepare, sign, and execute under this authority:

• Form 940, Employer's Annual Federal Unemployment Tax Return
• Form 941, Employer's Quarterly Federal Tax Return
• Form 943, Employer's Annual Tax Return for Agricultural Employees
• Form 944, Employer's Annual Federal Tax Return
• Form 720, Quarterly Federal Excise Tax Return
• Form 2290, Heavy Highway Vehicle Use Tax Return
• Form CT-1, Employer's Annual Railroad Retirement Tax Return
• Form 1065, U.S. Return of Partnership Income

The manual cites Delegation Order 5-2 as the source of the authority for designated Revenue Officers and bankruptcy personnel.

The field visit comes first

The manual requires a field call before the officer uses 6020(b) authority, "to obtain information and ensure that the entity is liable for any returns" (IRM 5.1.11.7.7.1). At that contact, the officer is told to set a specific date for filing and paying and to gather enough information to prepare accurate returns if the business does not file, such as:

• Total wages, number of employees, and tax withheld for each delinquent Form 941, 943, or 944
• The states in which wages were paid, for Form 940
• For a partnership, the number of partners, their identifying information and interest percentages, and gross income, along with the partnership agreement and the last filed Form 1065 if possible
• For Form 2290, the type of truck, number of axles, gross weight, and tax due

The manual also tells officers to "advise taxpayers who are personally contacted that failure to file by the specified date will be considered a refusal to file. This could subject the taxpayer to a fine, criminal penalties, or both, under IRC 7203." Where it applies, the officer is to explain the trust fund recovery penalty.

How the IRS builds the numbers

When the business does not file by the date, the officer prepares the returns. IRM 5.1.11.7.7.2 tells officers to use state wage information, state reverse file matching data, or other reliable sources to determine wages, withholding, and other figures, and to fully document the basis for each assessment on Form 5604, Section 6020(b) Action Sheet.

When actual amounts are missing, the manual supplies formulas:

The manual also says not to "prepare a return to equal a credit balance on the delinquent module." The return is based on the officer's investigation, not on what you happen to have paid.

These formulas are reasonable tools for an agency with no records. They are not your payroll. If you cut staff, lost a contract, or closed a location, a formula built on your last filed quarter plus 2.5 percent per quarter can be far from the truth.

Letter 1085

The proposed returns arrive with Letter 1085. The manual says officers send the proposed 6020(b) returns and Letter 1085 to the taxpayer, keep copies in the case file, and, if the taxpayer files bankruptcy after the letter is mailed, inform Insolvency and continue unless instructed otherwise.

Under IRM 5.1.11.7.7.4, the officer processes the returns for assessment if the taxpayer fails to file the delinquent returns, or after 30 days have passed from the date Letter 1085 was issued. The returns are signed with a statement that they were "prepared and signed under the authority of Section 6020(b) of the Internal Revenue Code."

So Letter 1085 is your window. Thirty days.

Your options

File your own returns. This is almost always best. Your payroll records show actual wages, actual withholding, and actual deposits. Returns built from those records replace formula-driven numbers before they are assessed.

Request an Appeals conference. IRM 5.1.11.7.7.3 describes what happens if the taxpayer requests Appeals in an unagreed 6020(b) case. The case is forwarded to the Independent Office of Appeals, and the delinquent return module is held in suspense while the taxpayer exercises the right of appeal. If Appeals sustains the returns, Appeals signs them under 6020(b) and sends them for assessment.

Pay and resolve. If the proposed figures are accurate, filing and arranging payment closes the delinquency.

Doing nothing is not an option that ends well. The returns get processed, the tax is assessed, and collection follows.

Penalties on IRS-prepared business returns

A 6020(b) return is not just tax. For the failure-to-pay penalty, IRC 6651(g)(2) treats a return the IRS prepares under 6020(b) as the return filed by the taxpayer, so that penalty is figured on the IRS's numbers. For the failure-to-file penalty, IRC 6651(g)(1) says the IRS-prepared return is disregarded, so it does not stop that penalty from being computed as if nothing was filed. Interest runs on top of both. When the IRS's numbers are inflated by formulas, every one of those charges is inflated too. That is one more reason to get your own returns in during the Letter 1085 window.

Why the formulas usually overshoot

Look at the formula for a business with no recent data. The officer starts with wages from the last period the business satisfied, then adds 2.5 percent for every quarter since. A business that has been shrinking, or has closed, will see wages that keep climbing on paper. Withholding computed at 20 percent of those wages may bear no relation to what employees actually had withheld. The manual's approach is a reasonable default for an agency without records. It is a poor substitute for the business's own payroll data.

The trust fund problem

Employment tax returns carry a special risk for owners and managers. The manual tells officers to explain the trust fund recovery penalty when it applies. That penalty can make responsible individuals personally liable for unpaid withheld taxes. This site does not cover the penalty in depth, but if your business has unfiled Forms 941, assume the officer is also thinking about who is personally responsible, and get advice before giving statements about who handled payroll.

Business and personal returns travel together

A business that stopped filing usually has owners who stopped filing too. Partnership income flows to partners. Wages paid to owners appear, or should appear, on their personal returns. The IRS examination manual has a section on delinquent corporation, S corporation, and officer or shareholder returns, and another on delinquent partnership returns, reflecting how often these cases come in pairs (IRM 4.12.1.16). Plan to fix both together, starting with the six years the IRS normally enforces under Policy Statement 5-133.

A business owner's checklist

• Identify every unfiled business return by form and period.
• Gather payroll registers, bank records of payroll, and deposit history.
• Note the date the officer set for filing, and meet it.
• If Letter 1085 arrives, calendar 30 days from its date.
• Prepare accurate returns and deliver them to the officer.
• Review the owners' personal filing status for the same years.
• Get advice before discussing who was responsible for payroll decisions.