Inside a Substitute for Return: How the IRS Builds It

A substitute for return, or SFR, is the IRS's version of the return you never filed. People are often shocked when they see the number at the bottom. It is not a mistake. It is the predictable result of rules the IRS has written down in its own manual.

Once you understand how the SFR is built, you understand why filing your own return almost always beats it.

The legal authority: IRC 6020

IRC 6020 has two parts, and they are very different.

Section 6020(a) covers a cooperative situation. If you fail to file "but shall consent to disclose all information necessary for the preparation thereof," the IRS may prepare the return, and if you sign it, the IRS may receive it as your return.

Section 6020(b) is the one most non-filers meet. If you fail 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 section 6020(b)(2), a return made and subscribed by the IRS "shall be prima facie good and sufficient for all legal purposes."

That last phrase matters. The SFR is not a placeholder. It is legally sufficient to support an assessment. The IRS certifies it using Form 13496, IRC Section 6020(b) Certification, according to IRM 4.12.1.30.

Step one: income from information returns

The IRS knows what third parties reported about you. Employers send W-2s. Banks, brokers, and clients send 1099s. Mortgage lenders send 1098s. That data is the foundation of the SFR.

IRM 4.12.1.25.1 explains how the IRS treats that data. Under IRC 6201(d), the IRS has to verify information-return income with third parties only when the taxpayer reasonably disputes the income and has fully cooperated. If you do not respond, the manual says, "an income adjustment in the amount reflected on the IRP document is appropriate."

In other words, silence is treated as agreement. Every dollar reported on a 1099 goes on the SFR as income, whether or not it was really yours, and whether or not it was really profit.

Step two: business expenses are optional for the IRS

This is where self-employed people get hurt the most. IRM 4.12.1.25.2 says: "The IRS has no legal requirement to allow business expense deductions, including cost of goods sold, on a substitute for return (SFR) prepared under IRC 6020(b)."

It continues: "Industry averages and estimates should never be used in calculating an SFR tax liability." The examiner may consider business expenses only if the examiner has actual information or documentation from you.

So if you earned $90,000 in gross receipts on 1099s and spent $50,000 earning it, an SFR built without your records can tax the full $90,000. That is not a typo in the system. It is the rule. We cover the fix in self-employed with an SFR.

Step three: the standard deduction, and nothing else

For individuals, the IRS manual draws a clear line.

IRM 4.12.1.25.3 says mortgage interest from Form 1098 and other deductions like known real estate tax "should not be allowed as itemized deductions, unless the taxpayer submits a signed return electing to itemize." The reason given is that itemizing is an election, and only you can make it on a signed return.

IRM 4.12.1.25.4 goes further: "Deductions and credits (e.g., a Qualified Business Income (QBI) deduction, Child Tax Credit, etc.) will not be allowed on a substitute for return (SFR) prepared under IRC 6020(b)." The exception is the standard deduction for individuals.

Step four: filing status

Married couples often assume the IRS will treat them as filing jointly. It will not. IRM 4.12.1.24 explains that joint filing status depends on both spouses making an election and intending to file jointly, and "the IRS may not elect joint filing status on behalf of taxpayers in a return it prepares and signs under the authority of IRC 6020(b)." The manual says these taxpayers' filing status will generally be married filing separate.

Separate status often produces more tax than a joint return would. That gap can be recovered only by filing your own joint return. See married non-filers and filing status after an SFR.

Step five: penalties and interest

The SFR comes with additions to tax.

• Failure to file under IRC 6651(a)(1): 5 percent of the net tax due for each month or fraction of a month the return is late, up to 25 percent.
• Failure to pay under IRC 6651(a)(2): 0.5 percent per month, up to 25 percent. IRC 6651(g) says an SFR is treated as the return filed by the taxpayer for purposes of figuring this penalty.
• Estimated tax penalty under IRC 6654 may apply when tax was not paid in through withholding or estimates.
• Interest under IRC 6601(a) runs from the original payment due date.

The Automated Substitute for Return program calculates tax, penalties, and interest systemically on every proposed assessment (IRM 5.18.1).

What the finished product looks like

Put the pieces together and the typical individual SFR looks like this:

That is why SFR balances run high. Not because the IRS is padding the bill, but because the rules leave out nearly everything that would lower it.

Two important limits on the IRS

The manual does put a few limits on SFR construction. IRM 4.12.1.6 says examiners "should never determine income solely from statistical data." And IRM 4.12.1.25.1 requires third-party verification when information-return income is unusual on its face, such as an amount far out of line with prior years or inconsistent with your known occupation, and when information-return data is relied on to support a fraud penalty.

Those limits help at the margins. They do not change the basic design.

Who actually prepares the SFR

Two parts of the IRS build substitute returns. Examination prepares SFRs for cases assigned to field and office examiners, following IRM 4.12.1. The examination manual says that when a taxpayer is liable for filing and, after due notice, fails to do so, "an SFR will be prepared by Examination" (IRM 4.12.1.8.4). Collection runs the Automated Substitute for Return program, governed by IRM 5.18.1, which handles a large volume of individual non-filer cases through computer-generated calculations and letters.

The process differs, but the rules are the same. Both rely on information returns. Both leave out deductions and credits you did not elect on a signed return. Both start the clock on collection without starting the clock on assessment.

The examination manual also builds in a step that helps cooperative taxpayers. Before an examiner prepares an SFR, the examiner is supposed to advise the taxpayer to file all delinquent returns and to deliver them promptly with a written statement explaining the failure to file (IRM 4.12.1.7.2.1). That request is your opening to avoid the SFR entirely.

What happens next

After the SFR is prepared, you will receive a proposed assessment and then a statutory notice of deficiency. The notice gives you 90 days to petition the Tax Court. If you do nothing, the tax is assessed and collection begins. The notice process is covered in the ASFR 30-day letter and the CP3219N 90-day letter.

The best response at every stage is the same: file your own accurate return. The IRS's own manual calls the process of contesting an SFR by filing an original return a reconsideration (IRM 4.13.1.2). Your return, with your real deductions and your real filing status, almost always beats the IRS's version.