In short, when it
comes to taxes, do not discount the importance of the statute of limitations. It can be pretty satisfying to say to
the IRS, “Sorry, you’re too late.” Given the
importance of the statute—both to heading off audit trouble, and to knowing when
you can safely discard some of those receipts—it pays to be statute-savvy. In this
part of the tax law, the rules for corporations, partnerships, nonprofit organizations
and individuals are consistent. Here’s what
you need to know.
Normally, the IRS
has three years
The overarching federal tax
statute of limitations runs three years after
you file your tax return. But there are many
exceptions that give the IRS six years or
longer, as we shall see. But, starting with
the normal three years, how is that counted?
If your tax return is due April 15, but
you file early, the statute runs exactly three
years after the due date. So, filing early does
not start the three years to run. If you get
an extension to October 15, and file then,
your three years runs from then. On the
other hand, if you file late and do not have
an extension, the statute runs three years
following your actual (late) filing date.
Six years for large
The statute is six years if
your return includes a “substantial understatement of income.” Generally, this
means you have left off more than 25
percent of your gross income. Suppose
you earned $200,000 but only reported
$140,000? You omitted more than 25 percent, so that means you can be audited for
The circumstances can matter too.
Maybe this was unintentional or reporting
in reliance on a good argument that the
extra $60,000 wasn’t your income. That
means the six-year statute applies. But be
aware that the IRS could argue that your
$60,000 omission was fraudulent.
If so, the IRS gets an unlimited number
of years to audit, as we will see. What about
not an omission of income, but overstated
deductions? 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
Still, you must add to the
six-year category certain other items. 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.
For years, there was litigation over what
it means to omit income from your return.
Taxpayers and some courts said “omit”
means leave off, as in don’t report. But the
IRS said it was much broader than that.
Example: You sell a piece of property for
$3 million, claiming that your basis (what
you invested in the property) was $1.5 million. In fact, your basis was only $500,000.
The effect of your basis overstatement was
that you paid tax on $1.5 million of gain,
when you should have paid tax on $2.5 million.
In U.S. v. Home Concrete & Supply,
LLC, 1 the Supreme Court slapped down
the IRS, holding that overstating your basis
is not the same as omitting income. The Supreme Court said three years was plenty
for the IRS to audit. But Congress overruled the Supreme Court and gave the IRS
six years in such a case, so that is the current
law. Six years can be a long time.
foreign gifts and
Another hot button these
days involves offshore accounts. The IRS is
still going after offshore income and assets
in a big way, and that dovetails with another
IRS audit rule. The three years is also
doubled if you omitted more than $5,000 of
foreign income (say, interest on an overseas
This rule applies even if you disclosed
the existence of the account on your tax
return, and even if you filed a foreign bank
account report (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 FATCA, 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, so it pays to check out
the filing requirements for your situation.
How Long Can the IRS Audit?
Do not discount the importance of the statute
of limitations. It can be pretty satisfying to say
to the IRS, “Sorry, you’re too late.”