There is perhaps no worse a feeling to taxpayers than when they receive an IRS notice indicating their return has been selected for examination. Thankfully, Congress has placed substantial limitations on the IRS’ ability to examine returns and assess additional tax: a 3-year statute of limitations period. Under the general statute of limitations period, the IRS has three years after the return is filed to assess any additional tax. See I.R.C. § 6501(a).
As with many other provisions in the Code, the 3-year statute of limitations provision is not without its exceptions. For example, if the taxpayer fails to file an income tax return, the statute of limitations period remains open until the taxpayer files the return. Additionally, a taxpayer’s statute of limitations period remains open indefinitely if the IRS is able to prove that the taxpayer filed a fraudulent return. Finally, if the taxpayer omits a substantial amount of income from his or her return, the statute of limitations period remains open 6 years after the return is filed.
Aware of taxpayers’ attempts to evade tax by hiding funds overseas, in 2010 Congress added yet another exception to the general 3-year statute of limitation period. Under I.R.C. § 6501(c)(8), if a taxpayer fails to file certain prescribed forms with his or her income tax return, the statute of limitations period remains open until the forms are filed plus three additional years. Four such forms commonly required to be filed with the taxpayer’s return, and subject to I.R.C. § 6501(c)(8), are: (1) the Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund; (2) the Form 8938, Statement of Specified Foreign Financial Assets; (3) the Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations; and (4) the Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.
As a general matter, a U.S. person is required to file Form 8621 if the person is a U.S. shareholder who: (1) directly owns stock of a PFIC; (2) is an indirect shareholder of a PFIC and holds an interest in the PFIC through 1 or more entities; or (3) is an indirect shareholder of a PFIC through ownership of a grantor trust that owns an interest in a PFIC through 1 or more foreign entities. See Temp. Reg. § 1.1298-1T(b)(1). A PFIC, or Passive Foreign Investment Company, is generally a foreign corporation that has a certain amount of passive income or investment assets. Form 8938, on the other hand, generally requires individual taxpayers with certain foreign financial interests in assets to report those assets if the aggregate value of all those assets exceeds $50,000. See I.R.C. § 6038D. A U.S. person must file Forms 5471 and Forms 8865 if the person “controls” a foreign corporation or foreign partnership, respectively. See I.R.C. § 6038; Treas. Reg. § 1.6038-2(a)(2), -3(a)(1).
As discussed above, a taxpayer’s failure to file the forms when applicable results in an extension of the 3-year statute of limitations period to three years after the proper form is filed. Moreover, to ensure that these forms are timely filed, Congress added teeth to the 2010 legislation and provided that the extended statute of limitations period applies to all items on the taxpayer’s return unless the taxpayer is able to show reasonable cause for the failure to file. If the taxpayer is able to show reasonable cause, then the extended statute of limitations period applies only to the items required to be disclosed.
An example demonstrates the pitfalls inherent in I.R.C. § 6501(c)(8). Assume a taxpayer fails to file a Form 8938 in 2015 and also omits $10,000 of gross income received as an employee bonus in that same year. Seven years later, the IRS determines that the taxpayer failed to file the Form 8938. Under the general 3-year statute of limitations provision, the IRS would be statutorily barred from assessing tax with respect to the $10,000 of omitted gross income. Under this example, however, the IRS would be able to assess the additional tax with respect to the $10,000 of omitted employee compensation under I.R.C. § 6501(c)(8) unless the taxpayer is able to show that the failure to file Form 8938 was on account of reasonable cause.
In some cases, the extension of the statute of limitations period may not be the worst of the taxpayer’s problems. For example, a taxpayer’s failure to file Form 8938 subjects the taxpayer to a $10,000 penalty as well as a 40-percent underpayment of tax penalty attributable to the undisclosed foreign assets. See I.R.C. § 6038D; 6623(j)(3). Even worse, a failure to file Form 8938 may increase the government’s probability of obtaining a favorable criminal judgment against the taxpayer under I.R.C. §§ 7021, 7023, and 7206. See Treas. Reg. § 1.6038D-8(f)(2).
Given all the risks of failing to file the proper forms, taxpayers must remain vigilant in ensuring they are complying with their tax obligations, which includes the proper filing of each form each year. Only then will taxpayers be able to rest easy (or easier) knowing the IRS has its usual 3-year period to initiate an examination and assess additional tax. As a final note, although I.R.C. § 6501(c)(8) does not apply to extend the statute of limitations with respect to the FBAR filing requirements, taxpayers should ensure that those forms are filed separately as well, if applicable.