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Statute of Limitations for IRS Audits: How Does It Apply To Me?

The United States has a voluntary tax reporting system where individuals file annual returns stating their income and declaring taxes owed. This differs from an "involuntary" tax reporting system where the government simply sends you an annual bill for a flat tax or per capita tax scheme. It would seem that a voluntary reporting system creates all sorts of opportunities to cheat the tax man. How has such a system survived for all these years?

The answer lies in the fear and mystique of the IRS audit. Known by the Internal Revenue Service as an "examination", an audit is a review of one's tax year to determine whether additional taxes should be assessed. The thought of an audit conjures up fears of sitting across the desk of a revenue agent, being asked accusatory questions about income or deductions and ultimately being assessed a large tax bill. Others fear that the revenue agents will come to their home and business for an on-site examination of records, and some further fear that they will be arrested and prosecuted for tax evasion. Concern for an IRS audit is usually more than enough to scare most individuals into compliance with the tax laws.

However, the Internal Revenue Service cannot wait forever to assess additional taxes. If there were no time limits, the IRS could conceivably come back after a taxpayer over 10, 20 or 30 years later to collect back taxes when it is possible that the taxpayer no longer retains those records. Without retaining vital information, the taxpayer is at a severe disadvantage to defend him or herself from wrongful tax assessments. As a result, time limits are prescribed by law.

Generally, 26 U.S.C. ยง6501 imposes a deadline of three (3) years from the date the return was filed or the date the return was due (whichever is later) for the Internal Revenue Service to assess additional taxes.

However, there is an extended deadline of six (6) years from the date the return was filed or the date the return was due (whichever is later) for the Internal Revenue Service to assess taxes in the following situations:

  • Where there is a substantial omission of gross income in excess of 25% of the amount stated in the return;
  • Where there is an omission from gross an amount attributable to the basis of property in the return that is overstated by at least $5,000.00.
  • Where the taxpayer has failed to file certain tax forms related to foreign financial assets and the omitted income is more than $5,000.00.

There is NO DEADLINE to assess additional taxes where the Internal Revenue Service can establish the following:

  • The taxpayer filed a false or fraudulent return;
  • The taxpayer willfully attempted to evade tax;
  • The taxpayer failed to file a return.

Despite the seemingly long statute of limitations, the IRS practically tries to start and complete audits much sooner. If the audit is related to information related to tax credits such as verifying dependents, the IRS usually tries to initiate the audit within three to four months after the return but before issuing the refund check. The vast majority of other audits are initiated between 12 to 18 months after the tax return is due. According to the Internal Revenue Manual (Sec. 4.10.2.2.2), it is policy upon revenue agents for the "examination and disposition of income tax returns is to be completed within 26 months for individual returns and within 27 months for business returns" to ensure "all other processing can be completed within the statute of limitation". However, these policies are GUIDELINES, NOT LAW and the IRS is free to disregard its policies and assess taxes any time before the statute of limitations has expired.

It is generally advisable to keep all tax records for at least six years to cover the greater statute of limitations period, so that you are prepared to defend yourself in the event of an IRS audit. In reality, less than 1% of all tax returns are selected for audit so the chances of being examined in any given year are extremely low. However, in the event you are unfortunately selected, it is a good idea to be prepared and keep careful financial records to support the income, credits and deductions you may have claimed during the tax year in question. Remember, the fact that you received a refund check does not mean that you are in the clear either. Protect yourself by keeping careful records.

If you are facing an IRS audit, you have the absolute right to be represented at any stage of the proceeding. Do not hesitate to contact the tax professionals at Kershaw, Vititoe & Jedinak PLC for help with your tax issues today.

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