Some recent court decisions and legislation give the IRS more flexibility to apply a six-year audit statute of limitations in more of its cases.  The IRS even argues for no statute of limitation for audits in cases involving fraud or deceit.  This article discusses the various audit periods enforced by the IRS and when an extended audit statute of limitations may apply.  

Three-Year Statute of Limitations for Tax Audit

Generally, the IRS has three years to audit a tax return from the later of the due date or filing date.  If a tax return is filed, for example, on February 1st, the statute of limitations begins running on April 15th (the due date) and runs for three years.  If a tax return is filed after the due date, the state of limitations begins running on the actual filing date for three years.  Generally, once the three-year statute of limitations has run, the IRS cannot audit the tax return, unless the tax return is covered by one of the extensions.

Six-Year Audit Statute of Limitations for “Substantial Understatement of Income”

The IRS has six years to audit a tax return if it includes a “substantial understatement of income.”  A substantial understatement of income is defined as the omission of 25% of a taxpayer’s gross income.       

Six-Year Audit for Returns Having the Effect of Substantial Understatement of Income

While it is clear that a simple omission of 25% or more of gross income qualifies as a substantial understatement of income, it is unclear whether incorrect or fraudulent reporting of certain other numbers having the effect of a substantial understatement of income will allow for a six-year statute of limitations.  The IRS advocates for the latter, especially in circumstances involving an overstated basis in assets.   

Federal Courts Examine Six-Year Statute of Limitations: Grapevine Imports, Ltd.

Some federal circuit courts (the Fourth, Fifth and Ninth, California is in the Ninth circuit) have ruled that the IRS must stick to its three-year statute of limitations in most situations.  However, in March, 2011 in Grapevine Imports, Ltd., v. United States, the U.S. Court of Appeals for the Federal Circuit held that an overstatement of basis does give the IRS six years if that overstatement has the effect of a substantial understatement of income.  As additional courts review this Grapevine Imports ruling, we may see the IRS gaining similar victories.

HIRE Act’s Six-Year Statute of Limitations Period

As part of the new HIRE Act, passed March 18, 2010, any tax return in which a taxpayer fails to report income higher than $5,000 in foreign financial assets is subject to a six-year statute of limitations for audit rather than the general three-year statute.  This applies to any income tax returns filed after March 18, 2010 or any income tax returns that still had a running statute of limitations on March 18, 2010.

No Statute of Limitations for Some Tax Returns

There is no statute of limitations on certain returns.  Returns that are deemed fraudulent under IRS definitions may be audited at any time.  Also, if a tax return was never filed, the statute of limitations never begins to run and the audit can come at any time.  Although many circumstances extend the statute of limitations for the government to audit and collect from the taxpayer, refund checks will not be paid after three years.  Lastly, Californians should be aware that the general statute of limitations is actually four years (barring fraud, non-filing, or substantial understatement of income) for the California Franchise Tax Board.  

Deciding which statute of limitation applies to your tax controversy can be a challenging task that may be vigorously challenged by the government. The experienced attorneys at The Law Offices of Stephen Moskowitz, LLP can help you determine if you have a legitimate statute of limitations defense barring the IRS or State from pursuing your case. Allowing our law firm to represent you in a case with a statute of limitations issue may save you a great deal of time and money in the long run. Call us today at 1-888-829-3325 for your free attorney-client privileged consultation.