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When is three years not really three years? When it involves an IRS audit

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On behalf of Christopher Larson

Omitting income, failing to file, or having offshore accounts may mean increased exposure to a tax audit.

The IRS generally has three years in which to audit a tax return. But because nothing can be simple when it comes to taxes, Congress and the IRS have carved out exceptions to the three-year statute of limitations.

Below are outlined several of those exceptions. Please remember this article is not legal advice; if you have questions regarding an IRS audit, or whether the IRS can audit a previous tax return of yours, contact an experienced tax law attorney to discuss your situation.

Failure to file, omitting income and offshore accounts

Exceptions to the three-year SOL include:

  • Omitting of more than one-quarter of your income. The IRS has six years to audit any taxpayers suspected of omitting more than 25 percent of their annual income. More on this exclusion below.
  • Omitting certain forms. Of course, if you simply fail to file anything with the IRS, the agency has an indefinite time in which to audit returns until you do file. However, the IRS has a general policy of not enforcing the filing of returns past six years. You may also face criminal charges if you fail to file a return.
  • Certain offshore account reporting. For most foreign income reporting, including FBARs, the IRS has six years to audit a return. Certified foreign corporations who fail to file Form 5471 can be audited indefinitely.

This list is by no means exhaustive, and merely demonstrates that significant exceptions to the three-year statute of limitations exist.

In 2015, Congress expanded definition of “omitting income”

Omitting income can take many forms. A simple failure to report income is the most common. But other methods exist of hiding income from the IRS. One common dispute between taxpayers and the IRS is an overstatement on the cost basis of a home.

The cost basis of a home is the amount initially invested in its purchase or construction. Taxpayers must only pay income tax on the amount the home sold for above its cost basis.

In 2012, the U.S. Supreme Court held that an overstatement of tax basis was not equal to omitting income. In 2015, Congress amended the tax code and specifically made an overstatement of tax basis equal to an omission of income.

Because of the new law, passed in July, the IRS now has six years to audit a taxpayer who has sold his or her home.

Questions?

Even well-intentioned and compliant taxpayers breathe a sigh of relief when the statute of limitations passes for a tax return; no one wants to face an audit, even with nothing to hide.

Unfortunately, myriad exceptions exist that can mean an audit when you least expect it. If you are facing an audit or have legal questions regarding a previous return, contact Insight Law to discuss your situation.