6-YEAR STATUTE OF LIMITATIONS
How Long Does a Taxpayer Have to Maintain Tax Documentation to Support Tax Return?
A question taxpayers often ask is “How long must I maintain my tax records?” Unfortunately, there is not one answer, except, “It depends.” In most cases, maintaining three years of tax records is sufficient. If you own assets that are used in your business, the statute of limitations (SOL) could be five, seven, 27.5, or 39 years. If a taxpayer is found to file a fraudulent tax return, then the SOL never expires.
In the case of Manashi, U.S. Tax Court Docket No. 13034-13, the taxpayer was introduced to the 6-year SOL rules. Robert Manashi owned 100% of his S Corp. and failed to report $800,164, $850,295, $810,490 and $175,717 of his S Corp. income for tax years 2006 through 2009, respectively. The IRS assessed taxes of $259,436, $271,079, $256,230, and $68,266, respectively, for these tax years. Plus, the IRS assessed $171,002 of penalties. The taxpayer’s first mistake was to self-prepare his own return; and he compounded his tax problems with his second mistake, when he decided to represent himself in tax court.
The most significant objection raised by the taxpayer was that the IRS’s assessments for the tax years 2006 through 2008 were closed by the 3-year statute of limitations and the 6-year SOL did not apply. The 6-year SOL applies when a taxpayer omits more than 25% of his gross income. Mr. Manashi argued that the 6-year SOL should not apply because the Code provides that if adequate disclosure is made in the return that allows the IRS to ascertain the nature and amount of gross income omitted, the 6-year SOL does not apply.
What was the adequate disclosure the taxpayer argued that he had made? The taxpayers contended that adequate disclosure occurred by virtue of the fact that the S corporation reported some amount of gross receipts on its returns for each year and that the IRS “through internal data” would have had knowledge of the amounts deposited into the taxpayers’ bank accounts and could have discovered that gross receipts were erroneously reported for each year. However, the court found that reporting some amount of gross receipts offered no clue that other gross receipts had been omitted and nothing on the S corporation’s Form 1120S for each year reasonably alerted the IRS that gross receipts had been underreported.
Further, the taxpayers argued that Forms 1099 were filed with the IRS by the banks at which they maintained their personal and business accounts and those forms should have alerted the IRS to the omitted income amounts on account of the significant discrepancies between the S Corp.’s reported gross receipts and the amounts deposited into those accounts for each year. Moreover, the taxpayers asserted that the S Corp.’s clients filed Forms 1099 with respect to the payments made to the S corporation and that those forms should have similarly alerted the IRS to the omitted income. However, there was no evidence of any Forms 1099 issued by the taxpayers’ banks or the S corporation’s clients and none attached to the returns filed by either the taxpayers or the S Corp. In addition, any information from Forms 1099, if they were in fact filed, would not have been disclosed in the return, or in a statement attached to the return, as required under Code Sec. 6501(e)(1)(B)(ii). Therefore, the court held that the six-year period of applied with respect to the taxpayers’ assessments of deficiencies for the tax years at issue and that the notices of deficiencies were timely made.
What Can We Learn from this Case?
IRS auditors are trained to look for tax fraud – a willful act done with the intent to defraud the IRS. Most IRS auditors realize that the tax laws are complex and expect to find a few errors in every tax return. Some are willing to give the taxpayer the benefit of the doubt and don’t pursue fraud charges when honest mistakes are made. A careless mistake on a tax return may cost the taxpayer a 20% penalty. While 20% of the tax due is a costly penalty, it sure beats the cost of the IRS finding tax fraud – a 75% civil penalty. Hopefully the taxpayer in this case learned from his mistakes. If not, the IRS may impose the fraud penalty in the future.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.