Tax Myths About Irs Statute of Limitations

• Publication year: 2022
• Author: Written by Robert W. Wood

TAX MYTHS ABOUT IRS STATUTE OF LIMITATIONS

Written by Robert W. Wood

It would be extremely satisfying to say, "Sorry, IRS, you are too late to audit me!" It would save you stress and expense, and would avoid having to prove that you were entitled to a deduction or find receipts. The IRS statute of limitations is important for heading off audit trouble, whether you are an individual, corporation, partnership, or nonprofit organization. Here is what you need to know.

Myth #1. The IRS Has Three Years, and then You are Home Free. Not really. It is true that the main 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. Timing, therefore, can be critical. If your tax return is due on April 15, but you file early, the normal statute runs three years after the due date. As a result, filing early does not start the three years statute to run. If you get an extension and file on October 15, your three years runs from that later date. If you file late and do not have an extension, the statute runs three years following your actual (late) filing date.

The statute is six years if your return includes a "substantial understatement of income." Generally, this means you have left off more than 25% of your gross income. Suppose, however, that you earned $200,000, but only reported $140,000 of income. In this situation, you omitted more than 25%, so that means you can be audited for six years.

The circumstances can matter too. Maybe this was unintentional or reporting in reliance on a sound argument that the extra $60,000 was not your income. This means the six-year statute applies. But taxpayers must be aware that the IRS certainly 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 a situation where it is not an omission of income, but a return with 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.

Myth #2: Only Omitting 25% of Your income Triggers Six Years. Actually, the 25% is a practical and significant number. For years, there was litigation over what it meant to omit income from your return. Taxpayers and some courts said "omit" meant leave off, as in, do not report. But the IRS said that an act of omission was much broader than merely failing to report income.

Example: You sell a piece of property for $3,000,000, claiming that your basis (what you invested in the property) was $1,500,000. In fact, your basis was only $500,000. The effect of your basis overstatement was that you paid tax on $1,500,000 of gain, when you should have paid tax on $2,500,000.

In United States v. Home Concrete & Supply, LLC,⁰¹ the United States 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 of time for the IRS to perform an audit. But Congress overruled the Supreme Court...