Supreme Court to Decide on Tax Audit Statute of Limitations

By Ken Berry

The Supreme Court has decided to review Home Concrete & Supply, LLC v. United States, No. 09-2353 (4th Cir. Feb. 7, 2011), involving the statute of limitations on federal income tax deficiencies. Crux of the matter: Can the Internal Revenue Service (IRS) go as far back as six years to audit taxpayers, or is it limited to a three-year period?

The outcome will be significant to both taxpayers and the professional tax community. Essentially, it may reduce extended exposure to audits in certain situations.

The basic rules aren't in dispute. Generally, the IRS can assess taxes within three years of the original due date of the tax return. It doesn't matter if the tax return was filed before the due date. If a return is filed late without an extension, the statute runs three years following the actual (late) filing date.

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But the usual three-year period is doubled to six years for a "substantial understatement of income." For this purpose, a substantial understatement is an omission of 25 percent or more of income. The IRS has argued that any claim that effectively results in an omission of 25 percent or more of tax liability – such as using an inflated tax basis – adds an extra three years to the ticking clock.

Example: A taxpayer sells a piece of property for $3 million, claiming a basis of $1.5 million. In reality, the basis was only $500,000. The effect of the basis overstatement is that the taxpayer paid tax on $1.5 million of gain when the taxpayer should have paid tax on $2.5 million. The IRS argues that this is a substantial understatement that can trigger the six-year audit period.

In recent years, the lower courts have been divided on whether the IRS can go back six years to audit a return with a basis understatement or if the three-year rule applies. Now, the Supreme Court has agreed to settle the matter once and for all. The government’s opening brief on Home Concrete & Supply, LLC v. U.S. is due November 14, and it will likely be January or February before arguments are heard. A decision will be later still.

At least one thing is clear at this point: There is no statute of limitations where fraud is committed. The IRS can go back indefinitely to examine the worst tax cheats.

 


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