Missing Tax Returns: What You Don’t Know About What Didn’t Happen Published August 23, 2016
There are those who believe that if a tree falls in the woods, and no one is there to hear it, it doesn’t make a sound. Among them, potentially, is the loan underwriter running a public records search, confirms a business has no tax lien, and hangs up believing the coast is clear to advance funds. Unfortunately, this underwriter may have concluded to a false positive and missed a warning sign that noncompliance is quietly creating a risk that could ultimately leave collateral in jeopardy.
We believe that where there’s smoke, there’s usually fire. A missing tax return is often that smoke. In our experience, we have found that where there is one missing tax return, there is likely another, and many times there is also, or will soon be, a tax liability. Over the years we’ve seen the incredible significance of a missing return, the discovery of which is likely a telltale sign that other noncompliance issues, including existing or forthcoming tax liabilities, are at play.
Somewhere between neglect and outright malice lie the reasons that most unfiled tax returns are missing. Taxpayers often panic at the discovery that a tax deposit was missed, declined, or insufficient. They often think they’ll come clean and pay it off next quarter. Unfortunately, that quarter never comes, and all too often a small issue with one quarter becomes a year or several years of unfiled returns. For many business owners, the problem escapes their grasp so quickly that in their discouragement, they stop making tax deposits altogether. The mentality of the taxpayer can become “I don’t have the money so I will not file the return. If I do not file the return the IRS does not know what I owe them. I beat the system.” This is what lenders need to look out for.
It is a popular misconception that until or unless a tax return is filed, a balance due cannot be created. This myth contains hidden peril for lenders. Though a taxpayer may not file a return of his own volition, the IRS can and will make an assessment on their behalf, and that assessment is fully enforceable and collectible. Thus it is entirely possible that a lender might confirm there is no lien and no tax liability assessed, fund the client, and down the line find their collateral captured by a wrongful IRS levy collecting a tax liability no one ever saw coming.
Whether it’s one or twenty missing returns, the imperative is to get to the bottom of the issue quickly. Screening for missing returns is best performed concurrent with monitoring tax deposit compliance. For example, missing return coupled with a record of missing deposits raises an immediate red flag. Even when tax deposits are present, it’s necessary to evaluate whether they were timely and sufficient. With ongoing tax compliance monitoring, it is possible to be alerted to this situation before it endangers collateral, and to guide the client through filing the return, addressing the applicable penalties, and moving forward with confidence.
A missing tax return is always a smoking gun. Occasionally the required deposits were made and the return really did get lost in the mail. But more often than not, a missing return is a sign of other problems and hidden risks to lenders, and its discovery should always prompt an additional level of review in order to accurately assess the risk to the lender. Most critically, these are levels of scrutiny that many underwriters, focused on the detection of liens and liabilities, may be omitting from the due diligence process.
In the case of borrower’s missing tax returns, ignorance isn’t bliss.
