Collecting Back Taxes: The IRS Statute of Limitations Explained A Practice Essentials CLE Program Presenter: Benjamin A. Stolz, Esq. 1 Copyright 2011 OnePath Practice Management Advisors, LLC
Disclaimer This is a Continuing Legal Education (CLE) presentation, and it is not legal advice. This presentation was prepared for information purposes only for other lawyers only and deals with hypothetical or historical situations. The information is certainly not intended and should not in any way be construed as legal advice. Your receipt of this information does not in any way create an attorney-client relationship and cannot substitute for obtaining legal advice from an attorney. The presenter makes no claim about the correct interpretation of any law discussed in this presentation. The presenter does not make any claim about what the correct course of action might be in a particular matter. The presenter also does not make any claim that the information contained in this article is complete or correct. 2
Introduction "Collecting Back Taxes: The IRS Statute of Limitations Explained", is a survey course intended for tax controversy attorneys and bankruptcy attorneys. This presentation will answer fundamental questions related to how long the IRS has to collect back taxes and audit your client's income tax returns under a number of different scenarios, including, but not limited to: the effect of late filed tax returns, underreporting of income, and fraud. Reference will be made to code selected provisions of the IRS Code and Income Tax Regulations. This course will also explain when the statue begins to run and explain often overlooked and hard to understand "tolling events" that effect the running of the statute of limitations in key situations, including, by way of example, complaints to determine dischargeability of back taxes in the U.S. Bankruptcy Court. In particular, the Instructor will discuss Sections 6501(a),(e); 6020(b) and 6501(b)(3), 6501(c )(1),6501(c )(4), 6511(d)(1). If you have ever been unsure how the IRS statute of limitations works or how tolling events can effect the dischargeability of taxes in bankruptcy, this course is for you. 3
Are Death and Taxes Inevitable?! Many people are under the impression that the IRS has virtually forever to collect back taxes and arsenal of deadly collection tools at their disposal with little or no oversight.! Urban legends always have a grain of truth, but that s about it. Although the IRS indisputably wields an array of very powerful collection tools they don t have forever to collect back taxes and, for that matter, they cannot wait forever to audit your client s tax return.! Collection activity is governed by a statute of limitations as is the time within which the IRS can audit a tax return. However, the trick is knowing when the periods begin to run and what situations may toll those limitations period much to your client s chagrin. 4
The General Rule! Generally, there is a:! 3-year statute of limitations for the IRS auditing a tax return; and a! 10-year statute of limitations for the IRS collecting tax.! But, of course, they call it a general rule for a reason, because there are always exceptions. We will look at some of those in a moment, but it might help to know where to look for a few of these general rules. The Tax Code is not always a quick or easy read and the Regulations even less so. 5
The General Rule - Assessment! Under section 6501(a) of the Internal Revenue Code (Tax Code) and section 301.6501(a)-1(a) of the Income Tax Regulations (Tax Regulations), the IRS is required to assess tax within 3 years after the tax return was filed with the IRS.! Proceeding initiated against taxpayers in court are covered under 301.6501(a)-1(b) of the Tax Regulations and no proceeding in court by the IRS without assessment for the collection of any tax can begin after the expiration of 3 years. 6
A Few Exceptions! Under section 6501(e) of the Tax Code and section 301.6501(e)-1 of the Tax Regulations the statute of limitations is 6 years if the taxpayer omits additional gross income in excess of 25% of the amount of gross income stated in the tax return filed with the IRS.! And, if the tax return was prepared by the IRS under the authority of section 6020(b) of the Tax Code the statute of limitations does not apply. See section 6501(b)(3) of the Tax Code and section 301.6501(b)-1(c) of the Tax Regulations. 7
A Few Exceptions! The statute of limitations does not apply in the case of a false tax return or fraudulent tax return filed with the IRS with intent to evade any tax. See section 6501(c)(1) of the Tax Code and section 301.6501(c)-1 of the Tax Regulations.! So, if your client is engaged in illegal conduct, they should not expect protection from the statute of limitations. The limitations period is for honest taxpayers that have provided the IRS a legitimate opportunity to collect the unpaid tax assessment. 8
The General Rule - Collections! For assessments of tax or levy made after November 5, 1990, the IRS cannot either collect or levy any tax 10 years after the date of assessment of tax or levy. See Section 6502(a)(1) of the Tax Code and section 301.6502-1 of the Tax Regulations.! Court proceedings must also be started by the IRS within the 10 year statute of limitations. Section 301.6502-1(a)(1) of the Tax Regulations. 9
The General Rule - Collections! For assessments of tax or levy made on or before November 5, 1990, the IRS cannot either collect or levy any tax 6 years after the date of assessment of tax or levy. See section 6501(e) of the Tax Code.! If the 6 year period ends after November 5, 1990, the statute of limitations is 10 years. In order to come under the 6 year statute of limitations, the 6 year period must end prior to November 5, 1990. 10
Calculating the Limitations Periods! The 10-year period begins to run with the date of the assessment, not the tax year for which taxes are due. The date of assessment is the date the tax liability is assessed on a particular form at an IRS Service Center. When the applicable form is signed by an IRS official, the 10-year period for that tax liability begins to run.! For example, if the return for 1998 is not filed until 2001 and the tax is assessed in 2002, the 10-year period begins to run in 2002 and expires in 2012.! Note: Later additions of interest and late payment penalties (as well as other penalties) tacked onto the underlying tax debt must be collected within the same 10-year period. 11
When Does the Clock Start?! In order to determine when the collection period begins for a particular liability, the best practice is to obtain a transcript of the taxpayer s IRS account. Transcripts should exist for each tax year and provide basic information such as the date of assessment, date of filing, and tax liability.! For example, let s say you are a bankruptcy attorney evaluating the potential dischargeability of several tax years. You can order tax transcripts from any of the following service providers with written authorization from your client. IRS Form 4506-T (in your handouts):! CIN Legal Data Services at www.cinlegal.com; or! CoreLogic CredCo at www.credco.com! So, getting your hands on reliable data is just a few keystrokes away on the internet. 12
What is the IRS Form 4506-T?! Form 4506-T is an Internal Revenue Service (IRS) document that is used to retrieve past tax returns, W-2, and 1099 transcripts that are on file with the IRS. The document gives permission for a third party to retrieve the tax payer s data. The taxpayer must sign and date the 4506-T.! IRS Form 4506-T must be signed and dated by the taxpayer. The date is good for 120 days. This rule is strictly enforced by the IRS. Any 4506-T that appears to have an altered signature or data will be rejected by the IRS.! With the IRS Form 4506-T you can order 1040 (personal), 1120, 1065 (business), W-2, and 1099 transcripts.! An IRS Tax Transcript is a line per line breakdown of the full tax return or data filed by the taxpayer or employer (W-2 & 1099). The photocopy of the return is a copy of the return filed. Tax Transcripts are obtained much more quickly than copies of tax returns. The photocopy is obtained by using the 4506 (not the 4506-T) and takes around 60 days for the IRS to process. 13
What is the IRS Form 4506-T?! Form 4506-T is an Internal Revenue Service (IRS) document that is used to retrieve past tax returns, W-2, and 1099 transcripts that are on file with the IRS. The document gives permission for a third party to retrieve the tax payer s data. The taxpayer must sign and date the 4506-T.! IRS Form 4506-T must be signed and dated by the taxpayer. The date is good for 120 days. This rule is strictly enforced by the IRS. Any 4506-T that appears to have an altered signature or data will be rejected by the IRS.! With the IRS Form 4506-T you can order 1040 (personal), 1120, 1065 (business), W-2, and 1099 transcripts.! An IRS Tax Transcript is a line per line breakdown of the full tax return or data filed by the taxpayer or employer (W-2 & 1099). The photocopy of the return is a copy of the return filed. Tax Transcripts are obtained much more quickly than copies of tax returns. The photocopy is obtained by using the 4506 (not the 4506-T) and takes around 60 days for the IRS to process. 1
Can I Discharge the Tax Liability in Bankruptcy?! A different set of time limitations apply in the U.S. Bankruptcy Court for determinations regarding the dischargeability of unpaid IRS tax debts. The following is a summary of the periods you need to keep in mind when reviewing your client s IRS obligations: 1. THE THREE-YEAR RULE. 11 U.S.C. 507(a)(8)(A)(i). The tax year in question is over three years preceding the filing date of the bankruptcy. The three-year period is computed from most recent date the tax return is due for the tax year. Note: An extension to file the return extends the start date of the period. 15
Can I Discharge the Tax Liability in Bankruptcy?! A different set of time limitations apply in the U.S. Bankruptcy Court for determinations regarding the dischargeability of unpaid IRS tax debts. The following is a summary of the periods you need to keep in mind when reviewing your client s IRS obligations: 2. THE TWO-YEAR RULE. 11 U.S.C. 523(a)(1)(B); 11 U.S.C. 1328(a)(2). A tax return has been filed by the taxpayer for the tax year(s) in question at least more than two years preceding the filing date of the bankruptcy. 16
Can I Discharge the Tax Liability in Bankruptcy?! A different set of time limitations apply in the U.S. Bankruptcy Court for determinations regarding the dischargeability of unpaid IRS tax debts. The following is a summary of the periods you need to keep in mind when reviewing your client s IRS obligations: 3. THE 240-DAY RULE. 11 U.S.C. 507(a)(8)(A)(ii). The tax claim was assessed at least more than 240 days preceding the filing date of the bankruptcy (plus any period of overlapping time during which an offer in compromise was pending, plus 30 days). 17
Can I Discharge the Tax Liability in Bankruptcy?! An as stated elsewhere, Fraud and Tax Evasion will disqualify your client despite potential eligibility on other grounds. The return must also satisfy requirements 4 and 5 below: 4. NON-FRAUDULENT RETURN. 11 U.S.C. 523(a)(1)(C). 11 U.S.C. 1328(a)(2). The tax return in question was non-fraudulent. 5. NO WILLFUL TAX EVASION. 11 U.S.C. 523(a)(1)(C); 11 U.S.C. 1328(a)(2). The taxpayer has not engaged in activity deemed willful attempts to defeat or evade the tax. 18
A Few Caveats about IRS Collection Activity! The IRS is under no obligation to notify a taxpayer or a tax collection service that the tax liability is no longer collectible, even though the IRS s internal records may reflect that the debt has been discharged.! Second, if tax liens have been filed in your client s case, those liens could still be on file with the local recording office, even though they can no longer be enforced. Now, occasionally, the IRS will voluntarily file a Release of Lien and not inform the taxpayer, but don t count on the IRS to do this very often.! Finally, its not at all uncommon to find an unenforceable IRS lien filed on property after the underlying tax debt becomes uncollectible. Again, you cannot depend on the statute of limitation to prevent the IRS from taking action; it s simply too big to see its own toes and frequently makes mistakes like any large organization. 19
Extending the Limitations Period with Waivers! Not that long ago, it was common practice for the IRS to insist that taxpayers waive the statute of limitations on collections. It was not uncommon for the IRS to ask for waivers extending the period during which taxes could be collected for up to 20 or 30 years!! In fact, at least one egregious case, a taxpayer was forced to extend the collection period beyond their life own expectancy, in order to avoid a levy on their military retirement benefits. Fortunately, in 1998 Congress decided to curb such practices and enacted legislation that banned the IRS from using such waivers going forward.! As a result of this legislation, any waiver of the 10-year statute of limitations executed before December 1999 was set to expire on the earlier of: (1) the last day of the 10-year period; (2) December 31, 2002; or (3) in the case of extensions in connection with installment payment agreements, the 90th day after the expiration date specified in the extension. 20
Tolling Events! Although waivers are no longer the primary means of extended the statute, there are other events which can toll the statue of limitations. There are a number of other ways the 10-year collection period may be extended.! For example, during the period an Offer in Compromise pending, the statute of limitations is extended accordingly.! In addition, if a bankruptcy petition is filed by the taxpayer, while the bankruptcy proceeding is pending, the 10-year statute of limitations on collection is extended by the duration of the bankruptcy proceeding. 21
Tolling Events - continued! The filing of an IRS levy or a judgment entered in a Federal Court in a suit by the Department of Justice can also extend the 10-year period.! In addition, the IRS can ask the Department of Justice to institute a collection proceeding in Federal District Court. If such a proceeding is initiated and the United States Government prevails, then the statute of limitations on collection on that judgment is extended for the period generally allowed to collect such judgments, and such judgments can be renewed subject to the discretion of the Court.! Installment agreements can also toll the statute of limitations. For example, the limitations period is tolled until the 90th day after the expiration date specified in the extension. 22
Tolling Events - continued The following are conditions which extend the Assessment Statute Expiration Date:! IRC Section 6501(c)(6), Termination of Private Foundation Status! IRC Section 6501(c)(1), False Return! IRC Section 6501(c)(2), Willful Attempt to Evade Tax! IRC Section 6501(c)(3), No Return! IRC Section 6501(c)(5), Tax Resulting from changes in certain income or estate tax credits! IRC Section 6501(c)(7), Certain Amended Returns! IRC Section 6013(b), Joint Return After Separate Returns! IRC Section 6501(h), Net Operating Loss (NOL) or Capital Loss Carryback! IRC Section 6501(j), Credit Carryback (as defined in IRC Section 6511(a)(4)9c)! IRC Section 6501(i), Foreign Tax Carryback 23
Tolling Events - continued The following are conditions which extend the Assessment Statute Expiration Date:! IRC Section 6503(a), Statutory Notice of Deficiency! IRC Section 6503(c), Taxpayer Outside United States! IRC Section 6501 (e), 25% Omission! IRC Section 6501(f), 543(a) & 544, Personal Holding Company! IRC Section 6501(b)(3), Substitute for Return - SFR! IRC Section 6901, Transferees, & Transferors Transferred Assets! IRC Section 6229, Partnership Items! IRC Section 6503(h), Bankruptcy 24
Tolling Events - continued The following are conditions which extend the Assessment Statute Expiration Date:! IRC Section 6501(c)(4), Agreements that extend the time to assess! Returns with Extension of Time to File! IRC Section 1033(a), Involuntary Conversion! IRC Section 6501(c)(9), Gift Tax (Form 709)! IRC Section 1314 (b), Mitigation! IRC Section 664, Charitable Remainder Trusts! IRC Section 6501 (e) (3), Excise Tax Substantial Omission! IRC Section 6501(c)(8), Failure to Notify the Secretary of Certain unreported foreign transfers! IRC Section 6501(c)(10), Listed transactions! IRC Section 6501(m), Certain credits elected! Some Forms 2290 (Amended)! Special Tax Stamp - each location established ASED (Form 11C)! IRC Sections 6503-6504, Other circumstances 25
Quick Reference Chart Tolling Events Prior Bankruptcy 3-year Period 507(a)(8)(A)(i) 3 years from Due Date Tolled During Time in Prior Bankruptcy for Period of Overlap, Plus 90-Days. 507(a)(8)(G)*** 2-year Period 523(a)(1)(B) 2 years from Actual Filing Date N/A! 240-Day Period 507(a)(8)(A)(ii) 240 days from Assessment Tolled During Time in Prior Bankruptcy for Period of Overlap, Plus 90-Days. 507(a)(8)(A)(ii)(II) 10-Year SOL (Collections) Tolled During Time in Bankruptcy, Plus 6- Months. 26 U.S.C. 6503(h)(2) 3-Year SOL (Assessment) Tolled During Time in Bankruptcy, Plus 60- Days. 26 U.S.C. 6503(h)(1)! Offer in Compromise* Appealing a rejected OIC may toll the 3- year period. N/A! Tolled During Time in Prior OIC overlaps the 240-Day Period, Plus 30- Days. 507(a)(8)(A)(ii)(I) Possibly Tolled if Taxpayer signed OIC Form 656! N/A! Request for Due Process Hearing & Appeal Tolled During Time Hearing is Pending, Plus 90 days. 507(a)(8)(G)*** N/A! Tolled During the Time Hearing is Pending Overlaps, Plus 90-Days. 507(a)(8)(G)*** Tolled During Time in Appeal, Plus 6-Months. 26 U.S.C. 6503(i)(2)! N/A! Extension to File Return Amended Return Delays start of 3-Year Period to Extended Due Date. Delays Start of 2-Year Period to Date Return is Actually Filed.! Delays Start of 240-Day Period to Date Tax Return Actually Assessed. N/A N/A! If the Amended Return results in additional tax liability, the 240-Day Period begins anew as to the amount of the new liability. N/A! N/A! N/A! N/A! Audit or Additional Assessment N/A N/A! If the Amended Return results in additional tax liability, the 240-Day Period begins anew as to the amount of the new liability. N/A! N/A! Substitute Return Filed Signed OIC N/A Does not start 2-Year Period for Tax Return.! N/A N/A! N/A! N/A N/A! N/A Possibly Tolled if Taxpayer signed OIC Form 656 N/A! Other Agreed Tolling! N/A N/A! N/A Possibly Tolled if Taxpayer signed OIC Form 656 N/A! *Time includes time OIC is pending or in effect pursuant to 507(a)(8)(A)(ii)(i). **Other tax appeals may also toll the periods above and this chart should be considered a starting point to any research, not a definitive tool from which to draw final conclusions. *** Reference includes Hanging Paragraph. Refer to Discharging IRS Tax Liabilities in Bankruptcy: A Primer on Dealing with the IRS Copyright (c) 2010 OnePath Practice Management Advisors, LLC. for more information on this subject.
Claiming a Tax Refund! As you might expect, if you want money back from Uncle Sam, there is also a limitations period at work and one you would be well advised not to forget.! A taxpayer may file a claim for a tax refund of an overpayment of any tax within 3 years from the time the tax return was filed with the IRS or 2 years from the time the tax was paid to the IRS, whichever period is the last. If no tax return was filed with the IRS, the claim may be made within 2 years from the date that the tax was paid to the IRS. See section 6511(a) of the Tax Code.! However, under section 6511(d)(1) of the Tax Code a taxpayer may file a claim within 7 years if the tax refund pertains to a bad debt under section 166 or 832(c) or in connection with a loss from a worthless security under section 165(g). 26
Questions?! Thank you for attending! Please direct all questions to:! Questions@onepathlpm.com! Instructors will respond to all questions via e-mail and telephone contact following the close of the teleconference or webinar. It has been our pleasure to visit with you today. 27