Understanding Statute of Limitations on Tax Audits
Nobody wants to spend their whole life looking over their shoulder, wondering if the IRS is going to audit them.
Luckily, there is a statute of limitations on IRS audits and tax assessments. This time period is called the Assessment Statute Expiration Date (ASED).
The IRS must close the audit and impose any tax assessments imposed before the ASED expires. Any tax payment assessed after the ASED expired is an overpayment that the IRS must credit or refund.
You may have heard that the statute of limitations on audits is three years. This is generally the case, but not always. Depending on the circumstances, the IRS could have far longer to audit your return . . . and sometimes forever.
Let’s look at the main limitations periods.
Three Years
The general rule is that the IRS has a maximum of three years to audit your return and impose a tax assessment. The three-year period starts to run on the later of
- the due date of the return (usually April 15 or March 15 for calendar-year taxpayers) or
- the day you actually file your return.
Thus, if your return is due April 15, the three-year period starts on April 15 if you file early or on April 15.
But if you get an extension and file later than April 15, the period starts on the date you actually file.
For example, if you filed your 2020 return on April 15, 2021, the statute of limitations will expire on April 15, 2024. On that date, the IRS can no longer impose any tax assessments for 2020. If you filed on April 1, 2021, the statute would also expire on April 15, 2024. But if you filed on October 15, 2021, the statute doesn’t expire until October 15, 2024.
As a practical matter, the IRS usually audits returns 12 to 18 months after they are filed. IRS auditors are instructed to complete audits on individuals within 26 months of filing and complete business audits within 27 months. This allows the IRS an additional nine or ten months for all processing to be completed within the statute of limitations—including appeal, assessment, and the issuance of the closing letter.
If you’re an owner of a pass-through entity such as a multi-member LLC, an S corporation, or a partnership, the three-year limitations period does not start to run when the entity’s return is filed. It starts when you file your individual tax return. Each pass-through owner’s individual income tax return is treated as separate from the entity return, and the statute of limitations is computed separately for each return.
Keep proof of the date you filed your return. If you file electronically, the date of the electronic postmark is deemed the date of filing. If you file a paper return by regular mail, it is deemed filed on the date of the postmark—but only if the IRS actually received it.
Recommendation. It’s wiser to file a paper return by certified mail or a private delivery service—in this event, a “timely mailed, timely filed” rule applies, and the return is deemed filed on the date of mailing.
Five Years
A special five-year limitations period applies to some employers who claimed the Employee Retention Credit (ERC). For ERCs claimed for the third and fourth quarters of 2021, Congress extended the limitations period to five years for assessment of tax attributable to the ERC.
However, the Infrastructure Investment and Jobs Act retroactively limited the ERC for the fourth quarter of 2021, so for most taxpayers, the five-year statute of limitations applies only to ERCs claimed for the third quarter of 2021.
Any ERC claimed for the second quarter of 2021 or earlier quarters is subject to the normal three-year statute of limitations.
To determine the audit limitations period, payroll tax returns for a period ending with or within a calendar year that is filed before April 15 of the following year are treated as filed on April 15 of that following calendar year. Filing an amended payroll tax return to claim the ERC does not extend the statute of limitations.
Example. ABC Co. filed its quarterly employment tax return (Form 941) for the third quarter of 2021 on October 31, 2021. ABC later amended its Form 941 to claim the ERC on March 1, 2022. For purposes of the audit statute of limitations, the payroll tax return is deemed filed on April 15, 2022. Reason: the return was for the 2021 calendar year and was filed before April 15 of the following year.
The special five-year statute of limitations applies. Thus, the IRS has until April 15, 2027, to audit the return and assess additional tax because of ABC’s ERC.
Alert. On January 31, 2024, the U.S. House passed H.R. 7024 by a vote of 357-70, which would extend the statute of limitations on assessment for the ERC to six years after the latest of
- the date on which the original return for the relevant calendar quarter is filed,
- the date on which the return is treated as filed under the present-law statute of limitations rules or
- the date on which the credit or refund with respect to the ERC is made.
Six Years
The IRS generally doesn’t examine returns that are more than two and a half years old. But if a taxpayer engages in certain types of bad conduct, as described below, the IRS can go back as far as six years.
Substantial understatement of income. If you omit more than 25 percent of your gross income from your return, the limitations period is increased to six years. All omitted income items are combined to determine whether the 25 percent threshold is exceeded.
Example. Tina Taxpayer reports $200,000 of fee income and claims $150,000 in deductions on her 2020 Schedule C. She reports no other income on her return. However she failed to report $60,000 of interest income for the year. The unreported $60,000 equals 30 percent of the $200,000 gross income reported on her return, so the 25 percent threshold was exceeded, and the six-year limitations period applies.
Substantial overstatement of tax basis. Overstating the tax basis of an item of property results in an understatement of the taxable gain when the property is sold. Such an understatement is treated as an omission from gross income—and if it results in an omission of more than 25 percent, the six-year limitations period also applies.
Example. John sells a rental property for $2 million and claims a tax basis of
$1.5 million. When he files his taxes for the year, he reports a $500,000 gain from the sale and no other income.
Oops! The property’s basis was only $500,000. John’s overstatement of basis resulted in the omission of $1 million in gross income from his return—well over 25 percent of the $2 million in gross income he reported. The six-year limitations period applies.
Omission of more than $5,000 in foreign income. A six-year period also applies if a taxpayer omits more than $5,000 in gross income attributable to foreign financial assets—for example, interest earned from foreign bank accounts. This rule applies even if you disclose the foreign account to the Treasury Department’s Financial Crimes Enforcement Network by filing Form 114, Report of Foreign Bank and Financial Accounts (FBAR).
No Time Limit
There is no statute of limitations at all on IRS audits and assessments for taxpayers who engage in particularly egregious conduct.
No return filed. There is no statute of limitations where no return is filed—in other words, the IRS has forever to audit non-filers. This makes sense since it can take the IRS many years to discover non-filers.
Key point. This is one very good reason to always file a tax return, even when you don’t owe any taxes.
Fraudulent returns. There is also no limitations period on audits and assessments where a taxpayer files a false or fraudulent return with intent to evade tax. Filing an amended non-fraudulent return after a fraudulent return does not change this—it won’t begin a limitations period.
“Fraud” is not defined in the tax code or in IRS regulations. Instead, the IRS looks for indicators or badges of fraud—for example:
- Understating income
- Maintaining inadequate records
- Concealing income or assets
- Failing to cooperate with IRS auditors
- Engaging in illegal activities
- Providing incomplete or misleading information to a tax return preparer
- Filing false documents, including false tax returns
Fraud for these purposes is not necessarily limited to fraud by you. The IRS and the Tax Court take the position that if your tax return preparer committed fraud on your return, the fraudulent return exception can also apply to you.
This is so even if you did not know of the preparer’s fraudulent intent when you filed your tax return.
Filing Amended Returns
An amended return must be filed within three years after the original return was filed. If you file an amended return, the limitations period begins to run from the date you filed your original return, not from the date the amended return was filed.
If you file an amended return within 60 days before the three-year limitations period runs, the IRS has 60 days after it receives the amended return to make an assessment. For example, if you file on the day before the three-year statute ends, the IRS has an additional 59 days. However the limitations period is not extended if an amended return reports no net increase in tax owed.
Agreeing to Extend the Statute of Limitations
If you’re under audit, the IRS will ordinarily ask you to extend the applicable limitations period long before it ends. You do this by signing a consent form— typically Form 872, Consent to Extend the Time to Assess Tax.
You do not have to agree to extend the statute of limitations; it’s purely voluntary. But if you don’t agree, the IRS will issue the examination report and a notice of deficiency based on the information it has. Extending the audit gives you more time to provide further documentation, request an administrative appeal within the IRS at the conclusion of the audit, and/or claim a tax refund or credit.
You can negotiate the terms of the extension. Ask that the Form 872 consent be limited to specific items—those on which the auditor has more work to do. Also, agree to an extension for no longer than six months. These quite reasonable limitations narrow your risk of the IRS fishing further into your affairs.
Takeaways
Here are five takeaways from this article:
- Most tax returns must be audited within three years of the later of the due date or filing date. Once the statute of limitations expires, the IRS cannot audit a return or impose any tax assessments.
- A special five-year statute of limitations applies to employers who claimed the ERC for the third or fourth quarter of 2021. H.R. 7024 would extend the limitations period for ERC audits to six years.
- The statute of limitations is doubled to six years when taxpayers underreport their gross income by more than 25 percent or fail to report more than $5,000 in foreign income.
- There is no statute of limitations on IRS audits where a taxpayer files no return or files a false or fraudulent return with intent to evade tax. Such fraud by a tax return preparer can be imputed to the taxpayer.
- Taxpayers can, and routinely do, extend the applicable statute of limitations by signing a consent form.
