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By Jon Call, EA. Enrolled Agent and NTPI Fellow • CLAW Tax Group
The IRS filed your tax return for you. That sounds helpful. It usually is not.
When you do not file, the IRS can prepare a substitute for return from third-party reports alone. Wages. 1099s. Bank forms. It builds a bill from that stack. It often skips the costs that made the income possible. Then collection starts.
We just finished a federal case that shows how wide the gap can get. Results vary. Every fact pattern is different. Here is what happened for a married couple in Minnesota.
The IRS version of 2018
Our clients had not filed their 2018 federal return. One spouse ran a handmade jewelry business. The other had some 1099 consulting income.
The IRS prepared a substitute for return through its Automated Substitute for Return (ASFR) program. It used third-party documents only. It assessed the jewelry spouse alone as single. It put roughly $64,000 of business income on the account with zero cost of goods sold and zero expenses. No joint standard deduction. No credit for two children. No Earned Income Tax Credit. No Child Tax Credit.
Assessed tax was about $15,500. With penalties and interest, the balance sat north of $30,000. Collection had already started.
That is the SFR problem in one paragraph. Revenue showed up. Cost of producing it did not.
What the books actually showed
Once we reconstructed the books, the federal picture looked nothing like the substitute return.
They filed married filing jointly with two qualifying children. Jewelry gross receipts were about $230,000. Cost of goods sold was a little over $100,000. Operating expenses were about $95,000, including a home office. Net jewelry profit was about $29,000. Consulting income was about $23,000. Adjusted gross income was just under $50,000.
Income tax after the Child Tax Credit: $0. Self-employment tax was about $7,300. That was the correct total tax before refundable credits. Then roughly $2,800 in EITC and additional child tax credit. The IRS number was more than double mainly because the SFR counted revenue, not the cost of producing it.
What we did: audit reconsideration
A substitute return is not the final word. Publication 3598 explains audit reconsideration. You can ask the IRS to reevaluate an assessment when you disagree with the results of an IRS-created return under IRC section 6020(b), or when you have new information that was not considered before. IRM 4.13 says the same thing for substitute-for-return contests: filing an original delinquent return is how you challenge that determination.
For this couple, we used three moves.
1. FOIA for the ASFR case file. We wanted the IRS file, not just the notice on the kitchen table. A Freedom of Information Act request can pull the administrative records behind an ASFR assessment. That helps you see what third-party documents drove the bill.
2. Reconstructed books and a signed joint 2018 Form 1040. We rebuilt cost of goods sold, operating expenses, and home-office support. Both spouses signed a joint replacement return that matched those books.
3. Audit reconsideration package, mailed certified. We sent the signed return with a reconsideration letter to the campus address on the notice. Publication 3598 says Form 12661, Disputed Issue Verification, is optional but recommended to list each disputed issue. Documentation has to travel with the request. Certified mail gives you a delivery trail.
The IRS past-due returns page is blunt about substitute returns. The return the IRS prepares might not give you credit for deductions and exemptions you are entitled to receive. Filing your own return is still in your best interest. The IRS will generally adjust the account to the correct figures when you do.
What happened next
August 2025: engagement.
September 2025: FOIA request.
January 2026: replacement return signed and package mailed certified. Delivered four days later.
February 2026: claim-pending hold on the account.
August 2026: corrected return posts. Smaller balance notice.
September 2026: letter confirms the old assessment was reversed.
About 7.5 months from mailing to confirmation. About 13 months from start to finish.
The federal result (this case only)
The IRS reversed the original assessment. The SFR tax came off. The penalties and interest tied to that tax came off with it. The spouse's separate 2018 balance went to $0.
What posted instead was a joint return with a much smaller bill: tax after credits in the mid four figures, plus penalties and interest that had run since 2019. Altogether the new balance landed under $10,000. Versus the old SFR balance north of $30,000, the improvement was roughly $20,000.
That is one case. Results vary. Outcomes depend on your facts, your documents, and how the IRS applies the law to them. Nobody can promise the same numbers for your return.
Six teaching points from this file
1. An SFR is not final. You can still file your own return and ask for audit reconsideration. Pub 3598 and IRM 4.13 both treat an IRS-created return as something you can contest with a real filing and new support.
2. Cost of goods sold is often the biggest gap. Third-party reports show what buyers paid you. They do not show what inventory cost. Here, more than $100,000 in COGS never made it onto the SFR. About $95,000 in operating expenses did not either. For online sellers and makers, that gap alone can double a tax bill.
3. Filing status matters. Single versus married filing jointly changes the standard deduction, how income is stacked, and which credits are even in play. The SFR treated one spouse as single. The correct return was joint with two kids.
4. Penalties are a percentage of tax. Fix the tax base and the penalty math usually shrinks with it. Failure-to-file and failure-to-pay can both hit. When both apply in the same months, IRS guidance puts the late-filing piece at a maximum of 22.5% and the late-payment piece at a maximum of 25% of the unpaid tax. Same percentage rates. Smaller tax base. Smaller dollars.
5. Late filing can cost you a refund. It does not cost you the right to reduce what you owe. The IRS says you generally must file within three years of the return due date to claim a refund of withholding, estimated tax, or credits like the Earned Income Credit. That refund window can close. Reducing an unpaid SFR assessment through a correct return is a different problem. Do not confuse the two.
6. Get the IRS file when you need it. FOIA is one tool for the ASFR administrative file. Knowing what the IRS used beats guessing from a collection notice.
If you are sitting on unfiled years
Self-employed people, online sellers, and small business owners land in SFR territory more often than wage earners. Third-party income reports fire. Books stay unfinished. Then a substitute return shows up with revenue and almost nothing else.
If that is you, start with the returns themselves. Our unfiled tax returns page covers the filing path. If collection pressure is already on, our tax relief services overview maps the next options. When you want a straight read on your facts, contact us for a consultation.
I am Jon Call, EA, co-founder of CLAW Tax Group. I became an Enrolled Agent in 2012. We represent clients nationwide from our Twin Cities offices. We cannot promise any result. We can reconstruct the books, file the missing return, and put the right package in front of the IRS.
