Statutes of Limitation

Three-year Statute of Limitations

As a general rule, the IRS must assess tax, or file suit against the taxpayer to collect the tax, within three years after the return is filed [IRC Sec. 6501(a)]. The three-year period of limitation on assessment also applies to penalties. Under IRC Sec. 6665(a), additions to tax, additional amounts, and penalties (IRC Secs. 6651-6724) are assessed and collected in the same manner as tax. Furthermore, any reference in the Code to "tax" includes such additions and penalties.

The statute of limitation on assessment begins to run on the day after the taxpayer files the return [Burnet v. Willingham Loan & Trust Co., 282 U.S. 437, 2 USTC 655, 9 AFTR 957 (1931)]. Thus, the day of filing is excluded from the computation of the three-year period. For example, if a taxpayer files her Form 1040 return for 1997 on April 15, 1998, the IRS must assess any deficiency on or before April 15, 2001.

When a Return Is "Filed"

The timely mailing of a return is treated as timely filing [IRC Sec. 7502(a)]. That is, a return timely mailed to the IRS, even though received by the IRS after the return's due date, is deemed delivered to the IRS on the date of the postmark stamped on the envelope by the U.S. Postal Service.

The Taxpayer Bill of Rights II (TBOR2) amended IRC Sec. 7502 so that tax information sent through a designated private delivery service qualifies under the timely mailed/timely filed rule. Before this amendment, tax forms sent to the IRS through private delivery services before the tax deadline but received by the IRS after the deadline were not considered timely filed. TBOR2 also gives the IRS the authority to treat services from the designated private delivery services as equivalent to U.S. certified or registered mail [IRC Sec. 7502(f)].

Gotcha! A taxpayer who files a return with the wrong Service Center may not start the running of the statute of limitations [e.g., see Kathryn Winnett, 96 TC 802 (1991)].

The "timely mailing" rule described above does not apply if the IRS fails to receive the return, or claims not to have received the return, or loses the return. To avoid the open-ended assessment limitations period that applies when a return is not filed, many advisors recommend that all returns and other important forms be sent to the IRS via registered or certified mail, return receipt requested. If sent by registered or certified mail, the registration provides prima facie evidence that the form or document in the envelope was actually delivered to the IRS, and the registration date or the date stamped on the sender's receipt is treated as the postmark date [IRC Sec. 7502(c)].

Even with a certified mail return receipt, the taxpayer may still have the burden of proving the return was in the envelope for which the receipt was received. To avoid this problem, the practitioner might include a cover letter stating that the tax return is enclosed with an extra copy of the cover letter and tax return, and a stamped self-addressed envelope. These should be sent by certified mail and the cover letter should ask the IRS to return a stamped copy of the letter and the tax return in the enclosed envelope. This gives the taxpayer three documents to prove the IRS received the return: (1) the return receipt, (2) the stamped copy of the cover letter, and (3) the stamped copy of the tax return. If either the cover letter or tax return is returned, the IRS will have a very difficult time proving it did not receive the tax return.

Use of registered or certified mail is more important if the return or form is mailed in an envelope bearing a private postal meter postmark. When the postmark is from a private postal meter, the taxpayer proves timely mailing by showing the return or form was delivered by the U.S. mail within the normal period of time. If the return or form is not delivered within the normal period for delivery, the taxpayer is faced with the difficult task of proving the return was timely mailed. The taxpayer can prove timely mailing only by establishing (1) that the return or form was placed in the U.S. mail before the last collection time for that particular mailbox on the day in question; (2) that the delay was caused by a delay in the transmission of the mail; and (3) the cause of the delay [Reg. 301.7502-1(c)(1)(iii)(b)].

What Constitutes a "Return"?

A person required to file a return must do so "according to the forms and regulations prescribed by the Secretary" [IRC Sec. 6011(a)]. The person must sign the return in accordance with the Secretary's forms or regulations (IRC Sec. 6061). In addition, the return must contain or be verified by a written declaration made under the penalty of perjury (IRC Sec. 6065).

A statement made by a taxpayer disclosing his gross income and deductions may be accepted as a "tentative return" [Reg. 1.6011-1(b)]. If such a statement is filed by the appropriate due date, it will relieve the taxpayer from liability for delinquent filing penalties. However, the taxpayer must supplement the tentative return by filing a return on the proper form within a reasonable period of time [Reg. 1.6011-1(b)]. Thus, while the tentative return may enable the taxpayer to avoid penalties for late filing, the question remains whether it is sufficient to start the running of the statute of limitations for assessment.

Returns That Start the Running of the Statute of Limitations

The Supreme Court has identified the basic elements of a return that start the running of the statute of limitations on assessment [Zellerbach Paper Co. v. Helvering, 293 U.S. 172, 35-1 USTC 9003, 14 AFTR 688 (1934)]. Perfect accuracy is not necessary, provided the taxpayer purports to file a return, sworn to as such [Lucas v. Pilliod Lumber Co., 281 U.S. 245, 2 USTC 521, 8 AFTR 10907 (1930)], that shows an honest and genuine attempt to satisfy the law.

The Internal Revenue Manual states that a "processable return" must meet two requirements [IRM 4.10.12.1.3]. First, the taxpayer must satisfy the basic signature requirements of IRC Secs. 6061 and 6065. The failure to sign a return or deletion or alteration of the penalty of perjury statement constitutes a failure to make a proper return. Second, the taxpayer must provide sufficient information to enable the IRS to ascertain and assess the taxpayer's tax liability. However, for internal statute of limitations monitoring purposes only, the receipt of a blank return which contains tax protestor statements (on the face of the return or attached thereto) is to be treated as a valid filing [IRM 4.10.12].

Six-year Statute of Limitations

An extended six-year statute of limitations on assessment applies to returns that omit a substantial amount of gross income [IRC Sec. 6501(e)]. The extended statute gives the IRS extra time to identify and assess a deficiency in situations where the taxpayer's return gives no clue to the existence of the omitted income [Colony Inc. v. Comm., 357 U.S. 28, 58-2 USTC 9593, 1 AFTR 2d 1894 (1958).] The limitations period is extended with respect to the taxpayer's entire tax liability for the year, not just the specific omitted items of income. Under this rule, the Tax Court has allowed the IRS to amend its pleadings to increase the amount of the proposed tax deficiency attributable to the disallowance of certain depreciation deductions [Stephen Colestock, 102 TC No. 12 (1994)].

The statute of limitations is extended to six years when the taxpayer omits gross income in an amount exceeding 25% of gross income actually reported on the income tax return. Items of gross income are determined under IRC Sec. 61; however, gross income derived from a trade or business equals the total sales price before subtracting the cost of such sales or services [IRC Sec. 6501(e)(1)(A)(i)]. On the other hand, an item of income is not considered omitted from a return if the return or an attached schedule contains adequate information to apprise the District Director of the nature and amount of such item [Reg. 301.6501(e)-1(a)(1)(ii)].

Observation: There is no specific form on which to make the disclosure. The adequate disclosure determination is based on the facts and circumstances of each case. Adequate disclosure may include information from a combination of documents attached to the taxpayer's return, or in some cases, a combination of information from the return and information from another return such as a partnership or S corporation return in which the taxpayer is a partner or shareholder [Rev. Rul. 55-415; Berderoff v. Commissioner, 398 F.2d 132, 68-2 USTC 9486, 22 AFTR 2d 8222 (8th Cir. 1968)].

IRC Sec. 6501(e) applies only to innocent or negligent omissions of gross income. Therefore, a six-year limitation period does not apply to fraudulent omissions of gross income, which instead can be assessed at any time.

Once the taxpayer files a return that omits more than 25% of his gross income, he cannot later start the running of the "regular" three-year limitations period by filing an amended return that includes the omitted income [Badaracco v. Comm., 464 U.S. 386, 84-1 USTC 9150, 53 AFTR 2d 84-446 (1984)]. Instead, the taxpayer must "live with the six-year period specified in Section 6501(e)(1)(A)."

In court, the IRS has the burden of proving the 25% omission from income; that is, it cannot simply rely on the amount of unreported income asserted in the Notice of Deficiency [Guy G. Price, TC Memo 1978-196 (1978)].

An extended six-year statute of limitations on assessment also applies in the following situations:

1. Foreign constructive dividends includable in income under IRC Sec. 551(b) are omitted from the return [IRC Sec. 6501(e)(1)(B)].

2. Omitted items includible in a gross estate exceed 25% of the total gross estate reported on the estate tax return [IRC Sec. 6501(e)(2)].

3. Omitted gifts exceed 25% of total gifts reported on a gift tax return [IRC Sec. 6501(e)(2)].

4. Omitted excise tax imposed by Subtitle D of the Code (i.e., IRC Secs. 4001 through 5000) exceeds 25% of excise tax reported on an excise tax return [IRC Sec.6501(e)(3)].

5. A personal holding company fails to file the statements required under IRC Secs. 543 and 544 [IRC Sec. 6501(f)].

6. Certain tax crimes apply.

No Statute of Limitation

The Code states that the IRS can assess tax or bring a suit to collect (unassessed) tax at any time in certain situations [IRC Sec. 6501(c)]. Of the several situations listed, the following are the most prominent:

1. The taxpayer does not file a return [IRC Sec. 6501(c)(3)].

2. A false or fraudulent return is filed with the intent to evade tax [IRC Sec. 6501(c)(1)]. The IRS has the burden of proving this for each year it assesses tax under the unlimited limitations period of IRC Sec. 6501(c)(1) [Harold L. King, TC Memo 1979-359 (1979)].

3. The taxpayer attempts to defeat or evade any tax, other than income, estate, and gift tax [IRC Sec. 6501(c)(2)].

However, other situations in which the statute remains open include the failure to notify the IRS of certain foreign transfers [IRC Sec. 6501(c)(8)] and not showing the gift tax required to be shown on a gift tax return [IRC sec. 6501(c)(9)].

A substitute for return prepared by the IRS under the authority of IRC Sec. 6020(b) does not start the running of the statute of limitations on assessment [IRC Sec. 6501(b)(3)]. However, a taxpayer for whom a substitute for return was prepared can thereafter start the running of the three-year statute of limitations on assessment by filing a correct return.

In Badaracco, the Supreme Court held that filing a nonfraudulent amended return after filing a false or fraudulent return does not start the running of the statute of limitations on assessment. Once the false or fraudulent return is filed, the IRS can assess tax (or commence a suit for the collection of tax) at any time, and the taxpayer cannot reinstate the general three-year statute of limitations by filing an amended return. On the other hand, a correct return filed after a taxpayer has failed to file a return (even fraudulently) starts the running of the three-year statute of limitations on assessment.

Statute of Limitations for Certain Criminal Prosecutions

Generally, criminal prosecutions must begin within three years of the alleged crime (IRC Sec. 6531). However, certain crimes have a six-year limitations period. Several offenses subject to a six-year period include:

1. offenses involving the defrauding or attempting to defraud the United States or any agency thereof;

2. the offense of willfully attempting to evade or defeat any tax or the payment thereof;

3. the offense of willfully aiding or assisting in, or procuring, counseling, or advising, the preparation or presentation, under the Internal Revenue laws, of a false or fraudulent return, affidavit, claim, or document;

4. the offense of willfully failing to pay any tax or make any return at the time or times required by law or regulations;

5. offenses described in IRC Secs. 7206(1) and 7207 (relating to false statements and fraudulent documents); and

6. the offense described in section 7212(a) (relating to intimidation of officers and employees of the United States).

In addition to these offenses, several Circuit Courts have held that willful failure to "pay over" withholding taxes under IRC Sec. 6531(4) is also subject to the six-year statute of limitations [Porth v. U.S., 426 F2d. 519, 70-1 USTC 9329, 25 AFTR 2d 70-961 (10th Cir. 1970); Musacchia v. U.S., 900 F2d. 493, 90-1 USTC 70001, 71A AFTR 2d 93-3762 (2nd Cir. 1990); and U.S. v. Gollapudi, 130 F3d. 66, 97-2 USTC 50978 (3rd Cir. 1997)]. However, the Fifth Circuit Court has held that the six-year statute of limitations does not apply to the willful failure to "pay over" withholding taxes because the statute refers to "pay," rather than "pay over" [Block v. U.S., 660 F2d, 1086 (5th Cir. 1981)].

The three- or six-year period, whichever is applicable, does not run (i.e., is tolled) while the taxpayer is either outside the United States or a fugitive from justice (IRC Sec. 6531). Apparently, the mere absence from the U.S. tolls the statute. Thus, the statute does not run even when away from the country for a brief period of time for a legitimate business or pleasure trip [U.S. v. Myerson, 368 F2d. 393, 66-2 USTC 9753,18 AFTR 2d 5997 (2nd Cir. 1966)].

NEW DEVELOPMENTS - Statute permits tolling if individual is unable to manage financial affairs because of disability. Rev. Proc. 99-21, 1999-17 I.R.B. _, April 8, 1999. The Internal Revenue Service Restructuring and Reform Act of 1998 provides for tolling of the refund and credit limitations periods during times in which an individual is financially disabled. In general this means that the individual is unable to manage financial affairs due to a disability. This rule generally applies to all periods of disability. It does not apply, however, to any claim for credit or refund that is legally barred as of July 22, 1998. [Code Sec. 6511(h), added by P.L. 105-206, 105th Cong., 2d Sess., §3202 (July 22, 1998).]

Procedures released for requesting extension of time to file refund claim due to period of disability. The Service has issued guidance describing the information that is required for an individual to request that the limitations period for claiming a tax credit or refund be suspended due to financial disability. With the taxpayer's claim for a tax credit or refund, the taxpayer must submit a statement from his physician that contains the following information:

the name and a description of the taxpayer's physical or mental impairment;

the physician's medical opinion that the physical or mental impairment prevented the taxpayer from managing the taxpayer's financial affairs;

the physician's medical opinion that the physical or mental impairment was or can be expected to result in death, or that it has lasted (or can be expected to last) for a continuous period of not less than 12 months;

to the best of the physician's knowledge, the specific time period during which the taxpayer was prevented by such physical or mental impairment from managing the taxpayer's financial affairs; and a certification, signed by the physician, that, to the best of his knowledge and belief, the above representations are true, correct, and complete.

Additionally, the taxpayer must provide a written statement affirming that no person, including the taxpayer's spouse, was authorized to act on behalf of the taxpayer in financial matters during the period of disability. If a person was authorized to act on behalf of the taxpayer in financial matters during any part of the disability period, the taxpayer's statement should provide the beginning and ending dates of the period of time the person was so authorized.

Case I - Assessment Statute

Taxpayer recently filed eight years of delinquent returns. Here are the results of her filed returns and information about returns IRS filed for her under IRC Section 6020(b).

Results of the returns prepared:

Federal Refund: $453
1997: Federal Balance Due: $310

1996: Federal Refund: $860

1995: Federal Balance Due: $108 Per SFR: $920 Tax Due

+ Interest & Penalties

1994: Federal Refund: $220 Per SFR: $1150 Tax Assessed

+ Interest & Penalties

1993: Federal No filing requirement - gross income under filing requirement.

1992: Federal Refund: $90 Per SFR: $3280 Tax Assessed

+ Interest & Penalties

1991: No filing requirement; gross income was not determined.

"Look back" Assessment Statute/ Collection Statute

What assessments are valid and collectable?

STATUTE OF LIMITATIONS ON COLLECTION

The IRS has 10 years to collect assessed tax [IRC Sec. 6502(a)]. This 10-year period is similar to the three-year period the IRS has to assess tax in that there are certain events that can extend the statutory period past the 10-year threshold. The 10-year period begins to run on the day after the date of assessment; that is, the date of assessment is excluded from the computation of the 10-year period [Burnet v. Willingham Loan & Trust Co., 282 U.S. 437, 2 USTC 655, 9 AFTR 957 (1931)].

Example: 10-year period of limitation for collection of tax

Dan timely filed his 1997 Form 1040 on April 15, 1998, but on March 31, 2001, the IRS assesses additional tax. The IRS must collect the additional tax, or file suit against Dan, on or before March 31, 2011.

The collection limitations period was six years for taxes assessed before November 6, 1990, which means the current 10-year limitations period should apply only to taxes assessed after that date. However, a transitional rule applies to taxes assessed before November 6, 1990, if the prior six-year period had not expired as of November 5, 1990. (See the footnotes to IRC Sec. 6502.) The effect of this transitional rule was to limit the six-year collection period to taxes assessed before November 5, 1984.

Case II - Collection Statute

A new client contacts you on September 18, 1997 because IRS has placed a wage levy with his employer. Before you intervene you request a transcript of his account. Copies of the documents you receive from IRS follow.

What is your evaluation of his situation?

What type of advice should you offer?

EXTENSION OF STATUTE OF LIMITATIONS

3-4.20 The following will act to extend the statute of limitations for collection:

Waiver. The taxpayer signs a waiver of statute of limitations.

Absence from Country. The taxpayer leaves the United States for more than six months. [IRC §6503 (c)]

Bankruptcy. A bankruptcy by the taxpayer will extend the statute of limitations on nondischargeable taxes for the pendency of the bankruptcy plus six months (generally courts have held that the pendency of the bankruptcy is from the filing of a petition to date of discharge). [IRC §6503 (b), (i); see Representing the Bankrupt Taxpayer, another Tax Practice Workbook]