Thank you for your question about a year in which you had an unfiled tax return. It is understandable that you're confused about why you received a refund one year, but are now being told that you owe for an earlier year. I will try to explain what happened.
Substitute for Return
If the IRS shows that you presently owe $2000 for tax year 2001 and you did not file that return, then it is clear that the IRS has filed that return for you. This IRS substitute-for-return (or SFR) is based on whatever income was reported to the IRS for you on that tax year.
The balance they assessed for 2001 on the SFR did not take into account any business or personal expenses you may have had in that year that may have reduced the tax debt. You don't get any credit for deductions that you would be entitled to take, unless you inform the IRS.
You are allowed to replace any SFR with an SFR replacement that lists all your deductions. Once the IRS processes your return, it will adjust the assessment it made on the SFR. If the IRS has already collected from you for a debt that your SFR replacement proved you didn't owe, then you can get any money back that you paid to the IRS in excess of what you actually owe.
It can take the IRS a few years to catch the fact that you did not file and to file an SFR for you. In your case, it appears that the IRS did not file the SFR for you until after you received your refund for tax year 2005. If the SFR assessment had been in place, the IRS would have applied your refund towards the SFR balance owing.
IRS Collections
It is not just your raw tax debt that is recalculated, when you replace an SFR, but the penalties are, too. Any penalties the IRS hit you with are adjusted and figured back to the tax due date on the new assessment.
If you are facing collections for one or more SFRs, you may want to get professional tax assistance. If you work with a professional, they can access all your old income information that was reported to the IRS, even if you no longer have the records. The IRS has record of any income that was reported in your name, whether it was 1099 income or W-2.
I suspect you received a refund for tax year 2004 because the IRS had not computed the SFR balance for tax year 2001 and there was no assessment in place at the time you filed the 2004 return. This is quite normal as it often is several years after the filing due-date for the IRS to generate an SFR assessment.
However, it's not a good idea to delay the filing of the 2005 return. If you have a balance due on that tax return, failure to file and pay can result in large penalties and interest.
In sum then, I would recommend that you retain a firm to file a corrected 2001 return so that the IRS will set aside their SFR balance. In addition, they can complete your 2005 return.
If you want more information on IRS filings and back tax obligations, please read other information available at Bills.com.
I hope the information helps you Find. Learn. Save.
Best,
Bill
