With tax returns either filed, in progress for Americans abroad, put on extension… (or late because an extension was not properly filed), now is a good time to look at the various statutes of limitations (SOL) applicable to US tax matters.
What is a tax SOL? Simply, the SOL prescribes the length of time permitted to the Internal Revenue Service (IRS) to enforce the tax rules. If the length of time for a particular tax year has expired, then the IRS is forever barred from claiming that you owe more tax in that year. It is important to understand how the tax statutes of limitations work, because in certain cases, the statute of limitations will be longer than others or the statute of limitations “clock” will not start to tick at all. The devil is in the details and today’s post provides them.
The post will be discussing the statutes of limitations with regard to civil, as opposed to criminal, tax matters.
IRS has a Longer Time – Understatements of Income / Foreign Financial Assets
Once you file your income tax return, there are several possibilities with regard to the statute of limitations.
General Rule – Three Years: The general rule is that the IRS has three years after the later of the date the tax return was due or the date the return was filed, in order to assess tax. This rule applies if the tax return is timely filed or if it is filed late.
Substantial Understatement – Six Years: The statute can be extended to six years if there is a “substantial understatement” of income. This means the taxpayer omitted from gross income an amount properly includible in his income and that amount is more than 25% of the amount of gross income stated in the tax return.
FATCA – Six Years: Under a special rule added to the tax law by the notorious “Foreign Account Tax Compliance Act” (FATCA) in 2010, the statute can also be extended to six years if the taxpayer omits over $5,000 from gross income that is attributable to certain kinds of foreign financial assets.
If You Do Not File A Tax Return the Statute Never Starts to Run
It is critical to remember that the statute of limitations does not start to run unless you file your income tax return! In other words, not filing the return means that the statute of limitations “clock” simply never starts to “tick”. This will result in your looking over your shoulder forever, nervously wondering if the IRS is catching up to you, and never attaining peace of mind.
Many Americans living and working overseas are under the mistaken assumption that they do not need to file tax returns if they earn less than the so-called “foreign earned income / housing exclusion” amounts. Nothing could be further from the truth. Tax returns must still be filed in order to claim the benefit of these exclusions.
Delinquent filers should take prompt action for many reasons, including to start the statute running. See my US Tax Primer here, especially noting the sections titled: “Tax Information Reporting Requirements” and “Delinquent Tax Returns and FBARs” and “Options to Remedy Past Tax Noncompliance”.
The Statute will Never Start to Run – Incomplete Foreign Reporting / Fraud
If there is a failure to file certain foreign-related information returns with one’s income tax return, such as Form 3520 or Form 5471, the statute of limitations does not begin to run because the return is treated as “incomplete”. The statute is suspended until the foreign information is provided to the IRS.
Under certain tax rules that were enacted with FATCA in March 2010, the statute of limitations does not begin to run until the taxpayer has complied with all mandatory foreign reporting. This reporting can include information returns regarding ownership in foreign corporations, foreign partnerships, foreign trusts, information concerning “specified foreign financial assets” and many other transactions in the offshore context. Only when proper reporting is made will the statute of limitations begin. Furthermore, even though the statute starts to run, the entire tax return will remain open for IRS adjustments for a period of three years (rather than only for the portions of the return relating to the foreign reporting that had been missing).
Please see my blog posting here concerning special tax information reporting for “specified foreign financial assets”.
In the civil context, the statute of limitations also does not start to run if a tax return is false or fraudulent or if there is a “willful” attempt to evade taxation. This means the IRS can look back as far as it wants. When suing for civil fraud in the real world, it is rare that the IRS goes back more than 6 years since it has a significant burden of proof to meet in fraud cases. This burden becomes more difficult to satisfy with the passage of time, and in order to avoid the added difficulties of proving older charges, IRS usually (but not always) limits the matter to 6 years.
FBARs Have a Different Statute of Limitations
The notorious “Foreign Bank Account Report” (FBAR) is not a tax return. As many of my readers know, it takes its genesis from the Bank Secrecy Act and not the US income tax laws.
The FBAR statute of limitations for civil penalties is six years from the date of the “violation”. What is the date of the violation? Typically it will be the date the FBAR is due, but the FBAR remains unfiled by that date. The violation can also involve another FBAR misstep (omitting an account; incorrectly reporting the maximum value of the account).
The due date for the FBAR was recently changed to April 15 of the year following the calendar year to which the FBAR relates (e.g., the FBAR covering the 2018 calendar year is due April 15, 2019). Currently there is a six month automatic extension for FBAR filings (thus, the 2018 FBAR has an automatic extended due date until October 15, 2019). If not received on such date, that constitutes the date of the violation.
Significantly, unlike tax returns, the FBAR statute continues to run whether or not the FBAR was ever filed. This is good news for those in breach of their FBAR filings since the FBAR statute of limitations will bar enforcement by the IRS for civil violations once the SOL has passed even though an FBAR had never been filed.
Posted May 9, 2019
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