The Internal Revenue Service hasn't been under such intense public scrutiny since the hearings in the 1990s that led to the Tax Reform and Restructuring Act of 1998 (also known as the Taxpayer Bill of Rights 3). Last time, the targets were the audit and collections divisions. This time, the focus is on the IRS’s division on tax-exempt organizations.

But even amid the inquiries, the IRS has to go on collecting taxes. The nation’s coffers must be filled. So what happens when people don’t file tax returns — but should?

Before we start, let’s just consider the folks who don’t have to file at all. People whose source of income is primarily Social Security and interest and dividends below a certain threshold aren't required to file a tax return. In fact, to reduce the volume of tax returns, the IRS discourages them from filing altogether. So they don’t. Then they get nasty notices. Although they knew their income or profits from stock sales weren't high enough to be taxed — the IRS doesn’t know it until they file.

A firm TaxMama policy: Always file a tax return, whether you need to or not. In fact, file in every state where you had income. That triggers the statute of limitations on audits — giving the IRS just three years to question your tax return and your state about 4 years, depending on local laws. Too many people are suddenly hit for back taxes from 5 or 10 years ago. Filing stops those surprises.

Moving on to those people who should file, but didn’t. What happens to them?

In today’s electronic world, with so much cross-reporting and oversight, it is getting much tougher to fly under the tax. Employers are no longer as willing to hire well-paid workers without either putting them on payroll, or issuing them a Form 1099-MISC so they can file as independent contractors. After all, if there is no paper trail, the employer loses the deduction — and can get penalized.

Plus, nonfilers who live extravagant lives tend to get turned in by jealous exes and neighbors — either for spite, or for a reward. These reports, and the W-2s and 1099s, give the IRS a starting point for their investigation into tax delinquents. At the end of fiscal year 2012, the IRS had nearly 4 million investigations open.

OK, so we have an idea of how the investigations are started: third-party reports, cross-referenced by the IRS computers and snitches.

What happens next?

Advisers look to limit trust taxes

The IRS sends a letter to the nonfilers alerting them that a tax return hasn't been filed for a specific year. The letter provides a deadline for filing. If the notice is ignored, the IRS may send out another two or so. When all notices are ignored, the IRS sends the first wake-up call. It is called an SFR (or Substitute for Return). This is where the IRS prepares a tax return for you. The tax return is based on all the income that the IRS knows about (from W-2s, 1099s, brokerage statements, K-1s, and so on). The filing status is set to single, even if you’re married. No deductions whatsoever are taken. And if you have a 1099-B showing sales of securities, the SFR reports 100% of the sale as profit.

Ouch! These are superhigh amounts. That is why it is a wake-up call.

One young trust-fund baby got an SFR from the IRS assessing her for about half a million dollars of taxes on the sales of over $3 million worth of securities. She had never seen a dime of those profits. Why? Because her cost basis (the original price) for those securities was about $3.2 million. Since she had a loss on the sales, she didn’t think she needed to file a tax return. But how could the IRS know she sold at a loss — if she didn’t file a tax return and tell them? Fortunately, that was an easy problem to solve.

What can you do when you get an SFR?

You can ignore it, hoping it will go away. (Uh, it won’t. Things will get worse.)

You can contact the IRS and let them know you’ll be filing a tax return to replace it. (When you prepare a correct tax return, your balance due will probably drop dramatically — or disappear — like our trust-fund baby’s did. )

You can accept the IRS’s version of your financial life. (Then either pay the balance due, or find other alternatives. )

Naturally, the smartest thing to do is to file your own version of the tax return. You’ll be able to use the correct filing status (married, head of household, qualified widow or widower) — and take all relevant deductions and tax credits. In fact, if the return was due less than three years ago, you might even end up with a refund. Money in your pocket — just for not ignoring the IRS.

Suppose you figure that you’ve ignored the IRS this long, who cares? Why not go on ignoring it? (Don’t be surprised: People really do that. That is why tax-controversy firms, which charge thousands of dollars a pop to represent people who owe back taxes, are doing a land-office business.) You ignore the IRS’s substitute tax return — and the IRS starts taking away your money.

The IRS doesn’t need to go to court to hit your bank account, your wages, or even to tell your vendors (people paying you as a freelancer) to send your earnings to the IRS. You’re just suddenly going to get a notice from the IRS about two days after your rent or mortgage check bounces, or after you paycheck is cut to the bone.

To people who think they are invulnerable, it comes as quite a shock. This is the splash of ice water, after the wake-up call.

Believe it or not, you can stop the levy actions. Truly. Simply call the IRS and promise that you will comply.

Getting into compliance means two things. First, set up a firm schedule for when they can expect your unfiled tax returns to start showing up. Second, ensure this year’s taxes are paid. Show the IRS that your payroll withholding is adequate to cover the current year’s taxes. Self-employed folks must start making estimated tax payments. They must be high enough to cover the current year’s tax liability.

What if you file and you owe more than you can afford to pay right now?

Not a problem. You have three major alternatives.

Ask the IRS for an installment agreement. That will give you up to 10 years to pay off the balance due. (Consider this the monthly payments on the Lexus you’ll never drive.)

Ask the IRS for an Offer in Compromise (OIC) — where you pay pennies on the dollar. Don’t count on this. Most OICs are turned down — and it is a long, involved process.

File bankruptcy on the taxes due. Yup, if you know how, you really can bankrupt tax debt. But, you can’t bankrupt tax debt based on a substitute for return. You must file the real tax return and wait a couple of years or so to file your bankruptcy.

Bottom line? Ignoring the IRS isn't a good idea. Even if they are out of favor with the president of the U.S. — they are out there collecting taxes. Perhaps even yours.

Eva Rosenberg, EA is the publisher of TaxMama.com, where your tax questions are answered for free. She is the author of several books and e-books, including Small Business Taxes Made Easy. And she teaches tax courses at IRSExams.com and CPELink — including courses on settling tax debts.