Coming Home to an IRS Problem: Tax Debt and Unfiled Years After Release

The first weeks after release are a checklist of urgent things: a place to live, a job, an ID, a phone, supervision appointments. The IRS is rarely on that list. Then a notice arrives at a relative's house, or a new employer's payroll gets a levy, or the first tax refund in years disappears.

A tax problem after prison is a solvable problem. But it has to be approached in the right order, starting with facts, not fear.

Step one: find out what the IRS actually has

Do not guess. Get your account transcripts for every year since before the arrest. The IRS offers several ways:

• The Get Transcript tool on IRS.gov, which provides free transcripts once you can verify your identity online.
• Form 4506-T, to request transcripts by mail.
• A representative authorized on Form 2848, or a person authorized on Form 8821, can request them for you.

For each year, you want to know three things: Did I file? Did the IRS assess anything? What is the balance today? An account transcript will show assessments, payments, penalties and interest. A wage and income transcript will show the W-2s and 1099s the IRS received for that year, which helps you rebuild returns you never filed.

Step two: understand the clock that kept running

Once tax is assessed, IRC Section 6502(a) gives the IRS 10 years after assessment to collect by levy or court proceeding, subject to extensions and suspensions. Section 6503 lists events that suspend that collection period, such as the taxpayer being outside the United States or a bankruptcy case. Being incarcerated is not on that list.

That cuts both ways. Interest and penalties kept accruing while you were away. But the collection clock also kept running for the years that were assessed. For some old balances, a significant part of the collection period may already be gone. Know your dates before you agree to anything.

Unfiled years are different. If you never filed a return for a year, the IRS may not have assessed anything yet, so there may be no collection clock running for that year at all. Or the IRS may have prepared a substitute return for you from the W-2s and 1099s it received, which may not reflect the filing status, deductions or credits you were entitled to. The transcripts will tell you which.

Step three: deal with unfiled years

Unfiled years block almost everything else. The IRS online long-term payment plan requires that all required returns be filed. So do most other arrangements.

• Years with a refund. File them first if they are still within about three years of their original due date. IRC Sections 6511 and 6513(b) limit a late original return to refunding tax paid within the three years before filing, and withholding is treated as paid on the original due date. Older refunds are lost. See filing taxes while incarcerated for how that math works.
• Years with a substitute return. If the IRS assessed tax on a substitute return, filing your own accurate return may reduce the balance.
• Years with income in prison only. Small prison wages may not create a filing requirement. And remember that prison wages do not count for the earned income credit under IRC 32(c)(2)(B)(iv).

If the case involved tax crimes: restitution

Some people come home owing restitution in a criminal tax case. That debt can become an IRS assessment. IRC Section 6201(a)(4)(A) directs the IRS to "assess and collect the amount of restitution under an order pursuant to section 3556 of title 18, United States Code, for failure to pay any tax imposed under this title in the same manner as if such amount were such tax."

Two limits matter. Section 6201(a)(4)(B) says the assessment cannot be made until all appeals of the order are concluded and the right to appeal has expired. And Section 6201(a)(4)(C) says the restitution amount "may not be challenged... on the basis of the existence or amount of the underlying tax liability" in any proceeding under the tax code. In other words, the restitution order itself controls the amount. If restitution is part of your situation, coordinate with your criminal defense counsel and your supervision officer before you agree to an IRS payment plan, so the payments are applied the way the order requires.

Step four: choose a realistic payment option

Most people coming home have limited income at first. The IRS collection options are the same ones available to anyone whose income dropped:

• Short-term payment plan. Up to 180 days for individuals who owe less than $100,000, according to the IRS.
• Installment agreement. Monthly payments over a longer period. Online applications are available to individuals who owe $50,000 or less and have filed all required returns.
• Temporary delay of collection. If paying would leave you unable to meet basic living expenses, the IRS can delay collection after reviewing a financial statement such as Form 433-F or 433-A. Penalties and interest continue, and the IRS may file a tax lien notice.

I explain the order of operations, and why filing comes before paying, in what to do when you owe the IRS after losing your job. The same logic applies here. If old unfiled returns are the bigger issue, see GetIRSHelp.com's unfiled tax returns page.

Step five: protect the new paycheck

A new job is the foundation of reentry. Two tax steps protect it:

1. Fill out Form W-4 carefully. Under-withholding on a new job creates next year's balance and can default an installment agreement.
2. Respond to IRS notices immediately. If the IRS has an address for you, notices with deadlines will arrive. A levy on wages usually comes after several notices. Answering the early ones is how you avoid the later ones. Make sure the IRS has your current address. See changing your address with the IRS.

Questions to answer before you agree to anything

1. Which years are assessed, and what is the assessment date for each? That drives the collection period under Section 6502.
2. Which years are unfiled, and does any of them still have a refund inside the three-year window?
3. Did the IRS file substitute returns, and would my own returns lower the balance?
4. Is any part of the balance a restitution assessment under Section 6201(a)(4)?
5. What monthly payment can I actually keep while also meeting my supervision obligations and basic living expenses?

Write the answers down. They are the foundation for every conversation with the IRS that follows, and they keep you from agreeing to a payment you cannot keep.

Penalties: ask, with facts

Failure-to-file and failure-to-pay penalties under IRC Section 6651 can be removed for reasonable cause. The IRM's reasonable cause guidance, at IRM 20.1.1.3.2.2.1, lists unavoidable absence among the circumstances the IRS considers, and directs employees to look at the dates and reasons for the absence, how it prevented compliance, and whether you attended to your tax duties promptly afterward. Prompt action after release helps the argument. Waiting another two years does not.

The bottom line

Start with transcripts. Identify unfiled years, assessed balances and collection dates. File what needs filing, starting with years that still have refunds. Choose a payment option you can actually keep, and keep your new withholding right so you do not start a new debt.

You paid one debt to society. The IRS debt is just paperwork and arithmetic. Handle it like that.