If you are hiding income from the taxman–or just worried you might not be able to substantiate every deduction–are you at risk for three years, six years, or more? Taxes are horribly complex, and even innocent activities can be misinterpreted. That’s one of many reasons it pays to know how far back you can be audited. Start with the old rule that the IRS usually has three years after you file to audit you.
But there are many exceptions that give the IRS six years or longer. Several of those exceptions are so prevalent today that the six year statute of limitations is becoming more common. The three years is doubled to six if you omitted more than 25% of your income. For years, there was a debate over what it means to omit income from your return. Taxpayers and some courts said “omit” means leave off, as in don’t report. But the IRS said it was much broader, including reporting that has the effect of an omission of income.
Say you sell a piece of property for $3M, claiming that your basis (what you invested in the property) was $1.5M. In fact, your basis was only $500,000. The effect of your basis overstatement was that you paid tax on only $1.5M of gain, when you should have paid tax on $2.5M. In U.S. v. Home Concrete & Supply, LLC, the Supreme Court slapped down the IRS, holding that overstating your basis is not the same as omitting income. The Supreme Court said 3 years was plenty for the IRS to audit.
Then, Congress overruled the Supreme Court, and gave the IRS six years in such a case. Six years is a long time. Filing your tax return early won’t help either. The time periods can be even longer in some cases. The IRS has no time limit if you never file a return or file fraudulently. Even so, the practical limit for the IRS to go back is usually six years. Another scary rule is that the IRS can audit forever if you omit certain tax forms.
Plus, once a tax assessment is made, the IRS collection statute is typically 10 years. And, in some cases that ten years can essentially be renewed. That’s one reason the IRS can sometimes go back an astounding 30 years! In Beeler v. Commissioner, the Tax Court held Mr. Beeler responsible for 30 year-old payroll tax penalties.
Figuring out the applicable statute of limitations that applies to your situation–and then waiting it out–can be nerve-wracking. An audit can involve targeted questions and requests of proof of particular items only. Alternatively, audits can also cover the waterfront, asking for proof of virtually every line item. For all these reasons, it pays to know how far back you can be asked to prove your income, expenses, bank deposits and more.
Frequently, the IRS says it needs more time to audit. The IRS will ask you to sign a form extending the statute of limitations, usually for a year. If you don’t sign, the IRS will send you a tax bill, usually based on unfavorable assumptions. For this and other reasons, most tax advisers generally tell clients to agree to the extension. However, it’s best to get some professional advice about your own situation. You may be able to limit the time or scope of the extension.
Another hot button that impacts the statute of limitations involves offshore accounts. The IRS goes after offshore income and assets in a big way, and that dovetails with another IRS audit rule. The IRS also gets six years to audit if you omitted more than $5,000 of foreign income (say, interest on an overseas account). That matches the audit period for FBARs, annual offshore bank account reports that can carry civil and even criminal penalties far worse than those for tax evasion.
For all these reasons, be careful and keep good records. You should keep copies of your old tax returns forever. But after a time–many people say seven years–you should be able to throw out records and receipts. Yet some records such as improvements to property that go into your basis, are exceptions. If you remodel your kitchen and sell your house 20 years later, the receipts for your remodeling job are still relevant to your tax return.
The statutes of limitation applicable to your tax returns are important. Always check them carefully, including all exceptions. Being able to tell the IRS it is too late to audit can be, well, priceless.