How Long Can the IRS Wait Before Imposing Tax Assessments?

Hourglass and calendar - How long can the IRS wait before imposing tax assessments?

When taxpayers discover errors in their tax returns, or they learn they were supposed to file FBAR reports, the problem they uncover can sometimes span years. The larger these foreign financial accounts are, the quicker the unpaid taxes, penalties, and interest can add up. Is there any limit? How long can the IRS wait before imposing tax assessments and collecting back-owed taxes?

Uncovering Unpaid Taxes on Foreign Financial Accounts Can Take Years

The United States Bank Secrecy Act requires U.S. taxpayers to file Reports of Foreign Bank and Financial Accounts (FBAR) with the Financial Crimes Enforcement Network (FinCEN). These reports disclose all foreign financial accounts under the taxpayers' control with a balance of $10,000 or more at some point during the tax year. Since 2010, the Internal Revenue Code has also required taxpayers to disclose the existence of accounts totaling at least $50,000 on their 1040 tax returns every year.

The only formal notice a taxpayer receives that he or she may be required to report their foreign assets is in the small print on the taxpayer's 1040. If he or she does not use a tax preparer with foreign account experience, the obligation could be easily overlooked, resulting in the risk for unpaid tax assessments, interest, and penalties.

When that happens, it often can take years for the IRS or the taxpayers to discover the error. Often, the missing financial disclosures go unnoticed until the IRS issues a "John Doe" subpoena against the foreign financial establishment where the money is held. When that John Doe subpoena uncovers unreported assets, the IRS will often investigate and pursue unpaid taxes for each year the error occurs. But is there any limit to how far back the IRS can go?

The IRS has 3-6 Years to Issue Tax Assessments

In its first decision of 2018, Rafizadeh v Comm'r, Docket No. 4398-15, 2018 U.S. Tax Ct. LEXIS 1, the U.S. Tax Court took up the question of the Internal Revenue Code's statute of limitations. This is the legal window in which any IRS enforcement proceedings have to start. Rafizadeh had filed tax returns on time for 2006 through 2009. When a John Doe subpoena resolved on November 16, 2010, it revealed an unreported foreign account. The IRS waited until December 8, 2014 - 4 years later - to assess tax penalties for the unreported income. Rafizadeh said that was too late, but the IRS disagreed.

Under Section 6501, the IRS must generally assess taxes within 3 years from the date the tax return is due (without extensions) or when it was actually filed, whichever is later. When the a John Doe subpoena is issued, it suspends the deadline for an additional 6 months, or until the that summons reaches final resolution.

But in 2010, the U.S. Legislature passed the Hiring Incentives to Restore Employment Act. That law added Section 6038D, which required taxpayers to disclose foreign financial interests with an aggregate value of $50,000 on their 1040 tax returns. The law imposed a 6-year statute of limitations for the IRS to assess taxes for omissions of this information.

Does the 6-Year Statute of Limitations Apply Retroactively?

The question in Rafizadeh was whether the IRS had 6 years to assess taxes and FBAR penalties on tax returns filed before 2010, but which excluded accounts that would have required reporting in 2010. In other words, does the 6-year statute of limitations apply retroactively to tax returns filed before the HIRE Act, but where errors were discovered afterward? The U.S. Tax Court said no. The HIRE Act only applied to assets for which there was a reporting requirement at the time the tax return was incorrectly filed.

The court explained that the trigger to start the time limit on IRS enforcement was the failure to report assets. The timeline for that enforcement was different depending on what was omitted. If the assets qualified for disclosure under Section 6038D when the return was filed, then the IRS had 6 years to assess tax penalties. Otherwise, the IRS only had 3 years.

No matter how big the foreign financial accounts, the IRS can't reach back indefinitely to impose tax assessments for the omissions. Which statute of limitations will apply depends on whether enhanced reporting requirements apply, and when the returns were filed. If you are facing IRS tax assessments, talk to an experienced tax attorney to discuss your options and find out whether any defenses, like an expired statute of limitations exist.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years’ experience. If you have questions regarding tax assessments, contact Joe Viola to schedule a consultation.