What Triggers the 6 Year IRS Statute of Limitations?

The Internal Revenue Service (IRS) operates under time constraints for auditing tax returns and assessing additional tax. This period, the statute of limitations, provides finality for taxpayers. Once this window closes, the IRS is generally barred from collecting more tax for that specific year.

The length of this assessment period varies based on the accuracy and completeness of the filed tax return. The details of a return determine which timeline applies, making it important to understand the different circumstances.

The Standard 3 Year IRS Assessment Window

For the vast majority of federal tax returns that are filed accurately and on time, the IRS has a three-year period to assess any additional tax under Internal Revenue Code Section 6501. The three-year clock begins on the later of two dates: the date the tax return was actually filed or the original due date of the return.

For instance, if a taxpayer files their return on March 20, well before the typical April 15 deadline, the three-year statute of limitations will not begin to run until April 15 of that year. The IRS will then have until April 15 three years later to initiate an audit or assess more tax. This prevents taxpayers from shortening the assessment window by filing exceptionally early.

The same principle applies to taxpayers who utilize an extension to file. If an individual obtains an extension to file their return by October 15 and files on that date, the three-year period starts from October 15. If a return is filed late without a proper extension, the clock begins on the date the IRS actually receives the return.

Conditions Extending the Assessment Period to 6 Years

The standard three-year assessment window can be doubled to six years under specific circumstances involving significant errors on a tax return. This extension provides the IRS with additional time to uncover substantial discrepancies.

A substantial understatement of gross income is the most common reason for the six-year extension. This occurs when a taxpayer omits from their return an amount of gross income that is more than 25% of the gross income stated on the return. “Gross income” in this context means total income before any deductions and is not the same as Adjusted Gross Income (AGI).

To illustrate, consider a taxpayer who reports $120,000 of gross income. If the IRS later discovers that this taxpayer failed to report an additional $35,000 of income, the omission would trigger the six-year statute. The $35,000 omission is more than 25% of the reported $120,000 gross income ($120,000 x 0.25 = $30,000). The IRS would have six years from the date the return was filed, or its due date, to assess additional tax.

The six-year statute is also triggered if a taxpayer omits more than $5,000 of gross income derived from certain foreign financial assets. This rule can apply even if the omitted amount does not meet the 25% threshold.

Another trigger is the substantial overstatement of basis. Basis is the amount of your investment in an asset for tax purposes, typically its original cost. When you sell an asset, you calculate the taxable gain by subtracting your basis from the sales price. Overstating the basis can artificially reduce the reported capital gain, and if this leads to a substantial understatement of income, the six-year rule can apply.

Adequate Disclosure as an Exception

The six-year statute of limitations for a substantial understatement of income is not absolute. An amount of omitted income will not be counted toward the 25% threshold if the transaction giving rise to the income was adequately disclosed on the tax return or in an attached statement. This provision allows taxpayers to be transparent about uncertain tax positions without being penalized with a longer audit window.

Adequate disclosure involves clearly alerting the IRS to the nature and amount of a potential issue. Taxpayers can use Form 8275, Disclosure Statement, to disclose positions taken on a return. For positions contrary to a specific regulation, Form 8275-R is used. By completing and attaching one of these forms, the taxpayer flags the item for the IRS.

This act of transparency demonstrates a good-faith effort to comply with the law. As a result, even if the IRS disagrees with the taxpayer’s treatment of the item, the disclosed amount is not considered an “omission” for the purpose of the 25% test. This ensures the standard three-year statute of limitations applies to that issue.

Circumstances with No Time Limitation

Certain actions can eliminate the statute of limitations entirely. In these situations, the IRS has an indefinite amount of time to audit a return, assess additional tax, penalties, and interest. These exceptions are reserved for the most serious cases of non-compliance.

• Filing a false or fraudulent return. If the IRS can prove that a taxpayer filed a return with the intent to deceive and evade tax, there is no time limit on assessment. This requires the government to show that the taxpayer willfully and intentionally misrepresented material facts.
• A willful attempt to evade or defeat tax. This can encompass a broader range of behaviors than just filing a fraudulent return, but it similarly involves a deliberate effort to avoid paying a known tax liability. If willfulness is established, the statute of limitations does not apply.
• Failing to file a required tax return. The assessment period is triggered by the filing of a return; without that event, the IRS’s time to assess the tax for that year remains open indefinitely.