The Statute of Limitations for Assessment: The Taxpayer's Ultimate Defense to the IRS' Assessment of Additional Tax

One of the questions taxpayers regularly ask is: How long does the IRS have to propose and assess additional tax? Or as some taxpayers put it, “ How long before I can be sure I am safe from the IRS”? In this blog post, I will discuss the general rules relating to the statute of limitations (SOL) on assessment and the exceptions to the general rule.

As a general rule, the IRS must assess additional tax and propose penalties no later than 3 years after either a tax return is filed or the return’s due date, whichever is later. IRC Section 6501. An assessment is the recording of the tax debt on the books of the IRS. If a taxpayer files a return before the filing date, for example a Form 1040 filed on April 12th, for purposes of the assessment SOL the return is deemed to have been filed on the due date, i.e., April 15th. If a taxpayer files an extension to file a return, for purposes of the SOL, the return is considered filed on the date of IRS receipt or the extended due date (if mailed before the due date but received later). Subject to the exceptions discussed below, if the IRS fails to assess additional tax and penalties within this 3-year period, it is timed barred from doing so. 

The 3-year SOL can be suspended by a number of different things. The three most common are (1) bankruptcy by taxpayer, (2) issuance of a Notice of Deficiency by the IRS, and (3) taxpayer involvement in a third party summons enforcement action. If a taxpayer files for bankruptcy protection, the IRS cannot assess a tax debt during the automatic stay period. As a result, the SOL is suspended for the period of the automatic stay plus 60 days. Where the IRS assess additional tax after bankruptcy, the taxpayer should confirm that the assessment was not made during a period for which the IRS was stayed from doing so. Failure by the IRS to properly and timely assess a tax debt after bankruptcy can invalidate the assessment. When the IRS issues a Notice of Deficiency to the taxpayer, the SOL is suspended until either (1) the 90 days for filing a tax court petition have passed and no petition was filed, or (2) the taxpayer timely filed a petition with the tax court and the decision of the court is final. In addition, the IRS is given an additional 60 days after expiration of the applicable time period to make an assessment. Finally, if the IRS summons records from a third-party and the taxpayer institutes a proceeding challenging the summons or intervenes in a proceeding to enforce the summons, the SOL is suspended during the period of any proceeding and appeal. (Click here for a prior blog post discussing a taxpayer’s rights with respect to an IRS summons to a third party for records). 

The 3-year SOL may be extended by agreement where, prior to the expiration of the 3 years, the taxpayer executes a Form 872 agreement to extend the SOL to a specific date or a Form 872-A which extends the SOL indefinitely. When the IRS asks for the extension, the taxpayer is not required to agree, and whether or not to extend the SOL depends on the particular facts and circumstances. In Kunkel v. Commissioner, the 7th Circuit Court Appeals addressed the issue of a Form 872-A, drafted by the IRS and signed by the taxpayer, that had the wrong tax period. In Kunkel, the taxpayer’s representative was asked by the IRS to execute an extension of the statute of limitations for one of the years under examination, 2008. The representative executed the Form 872-A as drafted by the IRS agent, which said “the amount of any Federal Income tax due on any returns made by or for the above taxpayer for the period ended February 15, 2012 may be assessed at any time on or before December 31, 2012.” Thereafter, the IRS continued the examination, the results of which the taxpayer did not agree. The IRS issued a Notice of Deficiency for the year of examination beyond the general 3 year SOL. In response, the taxpayer filed a petition with the Tax Court challenging the timeliness of the Notice of Deficiency, because the Form 872-A had the wrong tax period, the period ending February 15, 2012, instead of November 30, 2008. Although neither party introduced testimony as to what the parties to the Form 872-A intended, the Tax Court concluded that there was a mutual mistake of facts and that the court had the power to reform the Form 872-A to reflect the parties’ true intent, as manifested by “clear and convincing evidence. The 7th Circuit agreed with the Tax Court and upheld the ruling but on a different basis. 

Where an original tax return omits items of income in an amount exceeding 25% of the gross income that was shown on the return, the SOL for assessment is 6 years instead of 3 years. IRC 6501(e). The 6-year SOL applies because the government is at a disadvantage in discovering an omitted item of income. A taxpayer can overcome the application of the 6-year SOL by establishing that the item of omitted income was disclosed in the return – or in a statement attached to the return – in a manner adequate to put the IRS on notice as to the nature and amount of such item. In United States v. Home Concrete, the US Supreme Court ruled that under the statute in effect at that time, the 6-year SOL did not apply when the 25% underreporting of income was due to the overstatement of basis in an item. After the Home Concrete decision, Section 6501(e)(1)(B) was amended to provide that “[a]n understatement of gross income by reason of an overstatement of unrecovered cost or other basis is an omission from gross income,” subject to a six-year statute of limitations. This change was effective for all tax years still open under the 3-year SOL at the time of enactment – July 31, 2015. 

When an original tax return was filed fraudulently with the intent to evade tax, there is an unlimited SOL. IRC 6501(c). The IRS bears the burden of proof with respect to the application of the fraud exception to the statute of limitations. When the IRS meets this burden, it has automatically met its burden of proof for the application of the civil fraud penalty. A number of recently-decided cases address the application of the unlimited SOL, where the fraudulent return at issue was due to conduct by a third party and not the taxpayer. In Allen v. Commissioner, the Tax Court ruled that the unlimited SOL applied in a case where the tax return preparer’s conduct, unbeknownst to the taxpayer, resulted in a fraudulent return. However, in BASR Partnership v. United States, the Federal Circuit held that 6501(c)’s suspension of the three year period of limitations for assessment for fraud or false return applies only when the taxpayer acts with the requisite intent to evade tax. As the judicial conflict deepens, this may be an issue that the U.S. Supreme Court is eventually asked to address. 

Where the taxpayer does not file a tax return, there is also an unlimited SOL unless and until the taxpayer files a return. If the taxpayer eventually files a late return, the 3 year SOL would apply, subject to the exceptions discussed above, and starts on the return filing date. Failure to file a return or filing a late return can have adverse consequences in bankruptcy. There are a number of recent bankruptcy and appeals court decisions holding that where a return is not timely filed, by even one day, under Bankruptcy Code Section 523(a) any taxes due for that year cannot be discharged in bankruptcy. see In re Fahey, 779 F.3d 1 (1st Cir. 2015); In re McCoy, 666 F.3d 924 (5th Cir. 2012); and In re Mallo, 774 F.3d 1313 (10th Cir. 2014).