IRS Statute of Limitations
How long the IRS has to audit and assess taxes is an important – and complicated – question.
The IRS Typically Has Three Years.
The overarching federal tax statute of limitations runs three years after you file your tax return. If your tax return is due April 15, but you file early, the statute runs exactly three years after the due date, not the filing date. If you get an extension, your three years runs from then. If you file late and do not have an extension, the statute runs three years following your late filing date.
Six Years for Large Understatements of Income.
The statute of limitations is six years if your return includes a substantial understatement of income. Generally, this means that you have left off more than 25 percent of your gross income. Maybe the understatement was unintentional or you reported in reliance on a good argument that the extra money was not your income. The six-year statute applies, but be aware that the IRS could argue that your omission was fraudulent. If so, the IRS gets an unlimited number of years to audit. The six-year statute of limitations does not apply if the underpayment of tax was due to the overstatement of deductions or credits.
Six Years for Basis Overstatements.
The IRS has argued in court that other items on your tax return that have the effect of more than a 25-percent understatement of gross income give it an extra three years. There was litigation for years over what it means to omit income from your return. Taxpayers and some courts said omit means to leave off, as in do not report, but the IRS said it was much broader.
The Supreme Court held that over-stating your basis is not the same as omitting income. The Supreme Court held that three years was plenty of time for the IRS to audit. Congress overruled the Supreme Court and gave the IRS six years in such a case, which is the current law.
Foreign Income, Foreign Gifts, and Assets.
Another hot issue is offshore accounts. The IRS is going after offshore income and assets which dovetails with another IRS audit rule: the three years is doubled if you omitted more than $5,000 of foreign income. This rule applies even if you disclosed the existence of the account on your tax return, and even if you filed an FBAR reporting the existence of the account. This six years matches the audit period for FBARs. FBARs are offshore bank account reports that can carry civil and even criminal penalties far worse than those for tax evasion.
Certain other forms related to foreign assets and foreign gifts or inheritances are also important. If you miss one of these forms, the statute is extended. In fact, the statute never runs. If you receive a gift or inheritance of over $100,000 from a non-U.S. person, you must file Form 3520. If you fail to file it, your statute of limitations never starts to run.
IRS Form 8938 was added to the tax law by the Foreign Account Tax Compliance Act. Form 8938 requires U.S. filers to disclose the details of foreign financial accounts and assets over certain thresholds. This form is separate from FBARs and is normally filed with your tax return. The thresholds for disclosure can be as low as $50,000. Higher thresholds apply to married taxpayers filing jointly and to U.S. persons residing abroad. The form is nothing to ignore. If you are required to file Form 8938 and skip it, the IRS clock never begins to run.
Ownership of part of a foreign corporation can trigger extra reporting, including filing an IRS Form 5471. Failing to file it means penalties, generally $10,000 per form. A separate penalty can apply to each Form 5471 filed late, incompletely, or inaccurately. This penalty can apply even if no tax is due on the whole tax return. If you fail to file a required Form 5471, your entire tax return remains open for audit indefinitely.
This override of the standard three-year or six-year IRS statute of limitations is sweeping. The IRS not only has an indefinite period to examine and assess taxes on items relating to the missing Form 5471, but also can make any adjustments to the entire tax return, with no expiration until the required Form 5471 is filed.
A Form 5471 is like the signature on your tax return. Without it, it is almost as if you didn’t file a return. Form 5471 is not only required of U.S. shareholders in controlled foreign corporations, but also when a U.S. shareholder acquires stock resulting in 10-percent ownership in any foreign company.
No Return or Fraudulent Return.
What if you never file a return or file a fraudulent one? The IRS has no time limit if you never file a return or if it can prove civil or criminal fraud. If you file a return, can the IRS ever claim that your return didn’t count so that the statute of limitations never starts to run? Yes. If you don’t sign your return, the IRS does not consider it a valid tax return. That means the three years can never start to run.
Another big problem is if you alter the penalties of perjury language at the bottom of the return where you sign. If you alter that language, it also can mean that the tax return does not count.
Amending Tax Returns.
Taxpayers must live by time limits, too. If you want to amend a tax return, you must do it within three years of the original filing date. You might think that amending a tax return would restart the IRS’s three-year audit statute It does not.
However, if your amended tax return shows an increase in tax, and when you submit the amended return within 60 days before the three-year statute runs, the IRS has only 60 days after it receives the amended return to make an assessment. This can present planning opportunities. An amended return that does not report a net increase in tax does not trigger an extension of the statute.
Claiming a Refund.
Getting money back from the IRS is difficult. If you pay estimated taxes, or have tax withholding on your paycheck and fail to file a return, you generally have only two years to try to get it back.
Suppose you make tax payments, but have not filed tax returns for five years. When you file those long-past-due returns, you may find that overpayments in one year may not offset underpayments in another.
Extending the Statute.
The IRS typically must examine a tax return within three years, unless one of the many exceptions discussed here applies, but the IRS does track the three-year statute as its main limitation. Frequently, the IRS says that it needs more time to audit.
The IRS may contact you asking you to sign a form to extend the statute of limitations. It can be tempting to refuse, as some taxpayers do. Doing so in this context is often a mistake. It usually prompts the IRS to send a notice assessing extra taxes, without taking the time to thoroughly review your explanation of why you do not owe more. The IRS may make unfavorable assumptions. Most tax advisers tell clients to agree to the requested extension.
You may be able to limit the scope of the extension to certain tax issues, or to limit the time. You should seek professional help if you receive such an inquiry.
Other Statute Traps.
Statute-of-limitation issues come up frequently, and the facts can be confusing. Consider what happens when an IRS notice is sent to a partnership, but not to individual partners. The audit or tax dispute may be ongoing, but you may have no personal notice of it. You might think your statute has run and that you are in the clear. The partnership tax rules may give the IRS extra time.
Also watch for cases where the statute may be held in abeyance by an IRS John Doe summons, even though you have no notice of it. A John Doe summons is issued to banks and other third parties who have relationships with taxpayers. You may have no actual notice that a summons was issued. Even so, there is an automatic extension of the statute of limitations in some cases. If you bought a tax strategy, the IRS may issue the promoter a summons, asking for all the names of client. While she fights turning those names over, the statute-of-limitations clock for all the clients is stopped.
Another situation where the IRS statute is held in abeyance is where the taxpayer is outside the United States. You might be living and working outside the United States and have no knowledge that the IRS has a claim against you. Even then, your statute of limitations is extended.
State Tax Statutes.
Some states have the same three- and six-year statutes as the IRS, but set their own time clocks, giving themselves more time to assess taxes. In California the basic tax statute of limitations is four years. If the IRS adjusts your federal return, you are obligated to file an amended return in California to match up to what the IRS did. If you do not, the California statute will never run out. In addition, as in most states, if you never file a California return, California’s statute never starts to run. Some advisers suggest filing nonresident returns just to report California source income to begin California’s statute. There can be many tricky interactions between state and federal statutes of limitations.
Keeping Good Records.
The statute of limitations is sometimes about good record-keeping. Proving exactly when you filed your return, or exactly what forms or figures were included in your return, can be critical. For that reason, keep good records, including proof of when you mailed your returns. The difference between winning and losing may depend on your records. The vast majority of IRS disputes are settled. Getting a good, or mediocre, settlement can hinge on your records.
If you file electronically, keep all the electronic data, plus a hard copy of your return. As for record retention, many feel safe destroying receipts and back-up data after six or seven years; but never destroy old tax returns. In addition, do not destroy old receipts if they relate to basis in an asset. For example, receipts for home remodeling 15 years ago are still relevant, as long as you own the house. You may need to prove your basis when you later sell it, and you will want to claim a basis increase for the remodeling 15 years back.
Ten Years to Collect.
Once a tax assessment is made, the IRS collection statute is typically 10 years. In some cases that 10 years can be renewed.