Non-Filers: IRS Will Not Prepare Your Return with QBI Deduction

When a taxpayer fails to file a tax return, the Internal Revenue Service (IRS) has the authority under Internal Revenue Code (IRC) §6020 to prepare a "substitute for return" (SFR) on the taxpayer's behalf. Generally, SFRs are detrimental to the taxpayer's overall tax situation. SFRs do not start the clock running for the three-year period for assessment, and the IRS is still permitted to proceed with collection activity. Moreover, the IRS is not going to assume that a taxpayer is entitled to a deduction for which it lacks evidence.

On December 9, 2019 the IRS issued a memorandum (memo) providing guidance regarding the qualified business income (QBI) deduction on an SFR.[1] Our readers may recall that under IRC §199A, QBI may be broadly defined as a taxpayer's ordinary income (minus ordinary deductions) earned from a passthrough entity.[2]Significantly, taxpayers (excluding corporations) may deduct an amount equal to the lesser of: (1) taxpayer's combined QBI, or (2) 20% of the excess of taxable income over the sum of net capital gain.

The memo definitively answers the question as to whether or not the IRS will include a QBI deduction in an SFR. Specifically, the memo states:

Therefore, while a taxpayer may be entitled to claim a QBI deduction on a filed return, the Service will not allow the QBI deduction on an SFR prepared under IRC section 6020(b).

Taxpayers should note that if they subsequently file an original return including the QBI deduction, the memo indicates that the IRS will then consider the validity of such deduction using the same guidelines for other items included on the filed return.

The memo states that this guidance is effective immediately and will revise Internal Revenue Manual (IRM) 4.12.1 and IRM 4.19.17 within two years of issuance.

If you have tax questions or concerns regarding substitute returns, contact Frost & Associates, LLC today at 410-497-5947.


[1] SBSE- 04- 1219- 0054 (Dec. 9, 2019). You can read the full memorandum at: https://www.irs.gov/pub/foia/ig/sbse/sbse-04-1219-0054.pdf.

[2] See our previous article "Section 199A: New 20% Pass-Through Deduction" at https://www.districtofcolumbiataxattorney.com/Articles/Section-199A-New-20-Pass-Through-Deduction.shtml.

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