IRS Audit Statute (2018) – Domestic vs Extended Foreign Income Rules

IRS Audit Statute (2018) – Domestic vs Extended Foreign Income Rules

IRS Audit Statute (2018) - Domestic vs Extended Foreign Income Rules by Golding & Golding

IRS Audit Statute (2018) – Domestic vs Extended Foreign Income Rules by Golding & Golding

The IRS statute for audits can be very daunting.

IRS Audit Statute

The IRS Audit Statutes are very complex, even for experienced tax practitioners. That is because the IRS does not make it very clear to the average taxpayer regarding when the statue begins, exceptions, exclusions, limitations — and the difference between the IRS auditing you and the IRS collecting money you owe.

IRS Audit Non-Technical Summary

We will provide a brief summary of how the statute of limitations works regarding audits. We will not be citing any code sections or inserting any technical jargon – just providing you with a brief understanding of the IRS audit statute.

What is an IRS Audit?

The IRS has the right to audit or examine your tax return. The IRS has multiple departments depending on whether you are self-employed, a large business versus a small business, or if you have international related issues, etc. But, all you need to know is that the IRS has the right to audit your return.

Who Gets Picked for an Audit?

Nobody really knows for sure. But, there are some factors that may increase the chance of being audited. They typically include, being:

  • A High-Net Worth Person
  • Self-employed
  • Foreign Income or Assets
  • Travel and Entertainment Expenses
  • Home-Office Deduction
  • Schedule A Deductions which seem Inflated
  • A W-2 Taxpayer who has a Losing Side “Business”

These are not the only factors to determine whether a person will be audited, but they are some of the more commonly known red flags.

IRS Audit Statute Does Not Run Until You File

This is very important: just because three years has past since the time the return was due, does not mean the statute of limitations has started to run yet; it hasn’t. The IRS Statute of Limitations to audit you does not begin until you file a tax return.

3 Year IRS Audit Statute of Limitations

Most of the time, the IRS only has three years to audit you from the tax return due date.

Therefore, if you filed a tax return before April of the current tax year, the statute of limitations still does not begin until April 15 (or 17th or 18th depending on the year). For example, if David’s 2015 tax return is due on April 15, 2016, but David files the return on February 1, 2016 – the IRS still has until April 2019 to audit David — even though David filed before April 15.

If you filed a tax return after the due date, the IRS has three years from the day you filed late.

6 Year IRS Audit Statute of Limitations

Under certain circumstances such as having a significant amount of unreported income (or improper deductions which deflated the income significantly) or foreign income of more than $5000 that stems from a section 6038 asset – the statute is extended to six years.

In other words, the IRS gets to tack on an additional three years to audit you. Therefore, using the example above, the IRS would have an additional three years audit if it is determined that David had significant amount of unreported income or over embellished deductions.

Practice Point

Typically, the IRS does not start by going back six years. Rather, the IRS will audit you for three years and then depending on the facts and circumstances of your situation expand the audit another three years.

Therefore, if you happen to be out of compliance for prior years then — even if you decide not to go back and file returns in prior years — you should consider being in compliance for at least the three most current years with either the IRS Offshore Voluntary Disclosure Program or IRS Domestic Voluntary Disclosure Program.

Why? Because even if you are audited for three years and can pretty much show that you’ve done your best to be in compliance  for the last 3-years, the IRS agent may have no aforethought to believe he or she could go back another three years, because there would be no facts or circumstances in your current three-year audit that would lead the agent to believe they had reason to go back another three years (see Offshore Disclosure Options below).

Forever Statute

If you never file a tax return, the statute of limitations does not begin to run and therefore technically the IRS has forever to audit that return – or at least until you file it.

Alternatively, if the IRS has enough facts sufficient to show you acted fraudulently, the IRS has the right to go back as far as it wants to audit you. In other words, if there are sufficient facts to show the IRS believes that you acted with the intent to evade or defraud the IRS, the mere fact that you filed timely returns – or even untimely returns – more than three or six years ago does not prevent the IRS from auditing those years.

Practice Point

It should be noted, that the IRS cannot just make unsubstantiated blind accusations in order to open up prior-year returns. Rather, the IRS still has the burden to show a potential fraud or that you acted with such reckless disregard that it would warrant opening up prior returns. (Note: the IRS tries to put the burden back on taxpayers on issues involving FBARs, but most courts will still require the IRS to meet its burden).

Offshore Voluntary Disclosure

If you are already out of compliance, one of the best ways to get back into compliance and either reduce or eliminate your penalties is through IRS offshore voluntary disclosure. Since you have to submit to either OVDP, Streamlined or Reasonable Cause before you are audited, time is of the essence.

At Golding & Golding, we focus our practice exclusively on IRS Offshore Voluntary Disclosure.