Are You at Risk of an IRS Audit, and How Far Back Can the IRS Go?

An IRS examination can result in no change or proposed adjustments; selection does not itself establish wrongdoing. Taxpayers may worry about having their tax return examined or about keeping sufficient supporting records. This article explains possible issues in an IRS audit and the difference between examination, assessment and collection deadlines.

IRS Audit Selection

The IRS audit process involves a review of the individual and/or business tax return(s) and supporting documents to confirm that the information has been reported correctly and that the tax due is accurate.

The IRS uses several selection methods, including statistical screening and examinations connected with other taxpayers. Selection does not necessarily mean a return is incorrect. The following are examples of reporting and substantiation issues to review, not a formula for predicting whether a particular return will be audited:

• Unreported taxable income: Differences between a return and third-party information may require explanation or correction.
• Self-employment: Sole proprietors generally report business income and expenses on Schedule C. Keep records supporting receipts, expenses and the business purpose of deductions; self-employment alone does not establish noncompliance.
• Changes in reported income: Retain records explaining significant differences from earlier years.
• Home-office deductions: Check eligibility and substantiation requirements for the applicable tax year and facts before claiming a deduction.
• Property or asset values: Support valuations used to calculate income, deductions or other tax items.
• Deductions: Confirm that charitable contributions, meals, travel and other claimed expenses satisfy the applicable eligibility, limitation and recordkeeping rules. Do not assume that entertainment expenses are deductible.
• Business or hobby: Whether an activity is carried on for profit depends on the relevant facts and circumstances, not merely the label used on the return.
• Vehicle use: A claim of 100% business use needs support in the actual facts and records. Personal use must be treated correctly.
• Errors and missing forms: The IRS can correct certain mathematical or clerical errors on a tax return. Other issues may require an amended return or further examination; a correction notice is not necessarily an audit.
• Income level and complexity: Review complex transactions carefully. Income level alone does not establish whether an individual return will be audited.

Audit coverage and enforcement priorities change over time. Historical funding announcements, staffing estimates and population-wide audit rates do not establish an individual taxpayer’s current audit probability. For related background, see our page on IRS audits.

It is important to understand your potential audit exposure and the issues that might constitute red flags for the IRS.  Tax lawyers and accountants are accustomed to monitoring their clients’ audit exposure.  However, all taxpayers should have a general understanding of the statute of limitations in this regard.

How Far Back Can the IRS Audit You?

A statute of limitations sets a legal deadline for a particular action. The assessment period generally limits when the IRS can formally determine additional tax; it should not be treated as a single universal limit on all examination activity. A three-year period is the general rule for income tax, but six-year and open-ended periods, agreed extensions and statutory suspensions can apply.

General Three-Year Assessment Period

The general income-tax assessment period runs for three years after a valid tax return is filed. Under section 6501(b)(1), a return filed before the prescribed filing date is generally treated as filed on that date, determined without regard to a filing extension. A return filed after that date during an extension generally starts the period when actually filed. Special postponements and other exceptions require separate analysis; do not calculate an individual deadline from a simplified calendar example.

Before the assessment period expires, the IRS may ask the taxpayer to agree in writing to extend it. Agreement is not compulsory. Discuss the request with a tax professional: declining an extension may cause the IRS to make a determination using the information already available.

Six-Year Assessment Period

There are exceptions to the three-year rule that turn on unreported income.

Under section 6501(e), a six-year period can apply when omitted gross income exceeds 25% of the gross income stated in the return. An overstatement of basis that understates gross income can count as an omission. The statute contains special gross-income definitions and disclosure rules, so the calculation requires care.

A six-year assessment period can also apply if omitted gross income attributable to specified foreign financial assets exceeds $5,000. This test applies without regard to the reporting threshold and certain exceptions under section 6038D. An account balance or a genuine gift is not itself omitted gross income. Merely listing an account on a tax return or filing an FBAR does not necessarily prevent this rule from applying; any adequate-disclosure exception needs its own analysis.

Open-Ended and Extended Assessment Periods

Important exceptions include the following; this is not an exhaustive list:

• No return filed: The general assessment period does not begin when a required return has not been filed. A return prepared by the IRS under section 6020(b) does not itself start that period.
• Fraudulent return: A false or fraudulent tax return filed with intent to evade tax can allow assessment at any time. An innocent error is not automatically fraud.
• Certain missing international information: Section 6501(c)(8) can keep the assessment period open until at least three years after required information under its listed provisions is furnished. This can concern foreign-corporation information on Form 5471, foreign-asset information on Form 8938, or foreign-trust information on Form 3520 when the relevant reporting provision applies. If the failure was due to reasonable cause and not willful neglect, the extension is limited to related items. A Form 3520 foreign-gift report is a separate reporting issue and does not make a genuine gift or inheritance taxable income merely because it must be reported.

Collection Statute of Limitations

Collection has a separate deadline. The IRS generally has ten years from the date of an assessment to collect the assessed tax and associated amounts. Certain events suspend or extend that period, and different assessments may have different collection deadlines.

Assessment and collection periods must be analyzed separately. The general three-year assessment rule has significant exceptions; the general ten-year collection rule is not an unconditional expiration date. Review the actual filing and assessment dates and any event that changes the applicable period.

Do You Need a Tax Attorney?

A tax attorney can help determine the applicable limitation rules, review potential examination issues and identify supporting records. If selected for an audit, counsel can advise on presenting and defending your tax return and evaluating proposed tax, interest and penalties. Representation does not guarantee a no-change result or relief from additional amounts.

The attorneys at Segal, Cohen & Landis (SCL) advise on the Internal Revenue Code, IRS procedures and tax examinations. Services may include helping clients:

• Communicate with the IRS and assigned auditors throughout the entire examination process.
• Present the supporting documentation with a view to best defend your tax return.
• Support the items reported on a tax return and challenge proposed additional assessments when the facts and law permit.
• Evaluate appeal options and available penalty relief, subject to the applicable requirements and deadlines.
• Improve records and reporting to address recurring issues; no adviser can guarantee freedom from future audits.

Attorney-client privilege may protect qualifying confidential communications made for legal advice, subject to exceptions and waiver. It does not automatically protect underlying facts, ordinary business records or every communication connected with return preparation. Ask counsel how privilege applies to the particular material and proceeding.

If you would like a complimentary consultation with one of our partner attorneys about your tax matter, please contact us. We can discuss the circumstances, possible approaches and anticipated fees; a consultation does not promise a particular outcome.