Exceptions to The Three-Year Statute of Limitations for IRS Tax Audits

The general rule of the IRS is to audit returns that have been filed in the last three years. Because of this, some taxpayers may breathe a sigh of relief once the three-year period has expired, but the rules regarding the statute of limitations are not quite that simple. There are circumstances where the IRS can go back even further to audit your return or assess additional tax, and the IRS has unlimited time to assess tax in the case of an unfiled return.

IRS Audits for Substantial Errors

If the IRS detects a substantial error on your return, the IRS can wait up to six years after your return was filed to conduct an audit. A substantial error involves an understatement of income of more than 25%, based on the income claimed on the return. Congress has extended this definition of a substantial error to include basis overstatements which result in less capital gains tax being owed after the sale of property. Some of those are discussed below.

IRS Audits of Foreign Income

The IRS has six-years for audits related to foreign asset reporting obligations, including Foreign Bank Account Reports (FBARs). This is one of the reasons it is risky to use a “quiet disclosure” or to simply begin filing FBARs in the current year without going back and amending the previous year returns using either the Streamlined Procedures or the Offshore Voluntary Disclosure Program (OVDP).

The IRS can assess FBAR penalties for each unreported account for each year, up to six years. The current penalty of $12,459 per non-willful violation can quickly add up to six figures in penalties if you have multiple unreported accounts over multiple tax years.

IRS Civil Tax Fraud Statute of Limitations

While the IRS must abide by the statute of limitations for criminal tax fraud cases, there is no limit to how far back they can go in a civil tax fraud case. Proving tax fraud is a difficult task, requiring a showing of intentional violation of a known legal duty, but is nonetheless something that taxpayers should be aware of, particularly if the IRS is examining your tax returns.

The IRS can also extend the statute of limitations by getting your consent. You should not give the IRS an extension without consulting with a tax audit attorney who can negotiate the length and scope of the extension or advise you to avoid giving the extension at all.