They say that relationships are all about timing. Putting aside the accuracy of that cliché generally, timing is certainly a key for taxpayers facing challenges by the Internal Revenue Service (“IRS”). Why? The law ordinarily provides that the IRS only has three years from the time taxpayers file particular returns to identify them as problematic, conduct an audit, and assert proposed changes. In other words, the normal rule is that the IRS cannot impose additional taxes or penalties against taxpayers after three years have lapsed, so they can rest easy. Given the massive volume of returns the IRS must process each year, three years can become a relatively short period.
Enter the special rules. The Internal Revenue Code features several exceptions to the normal three-year timeframe. For instance, taxpayers essentially give the IRS “involuntarily” extensions when they take or fail to take certain actions. Taxpayers can also “voluntarily” grant the IRS more time, if they believe that doing so benefits them somehow. They formalize matters by submitting a Form 872 (Consent to Extend the Time to Assess Tax) or similar document to the IRS. Importantly, the IRS must obtain the Form 872 before the pending assessment period expires because, when it comes to tax matters, the law is remarkably clear about its limits: Closed periods cannot be reopened.
The IRS now claims that this limitation does not apply when it comes to penalties stemming from foreign financial accounts. Indeed, internal documents that the IRS was recently forced to disclose reveal its belief that it can get extensions to impose FinCEN Form 114 (“FBAR”) penalties at any time, even after the normal assessment period has passed. This theory, still untested by the courts, could be a major issue for taxpayers with global reach.
Unintentionally Giving the IRS More Time
As mentioned above, taxpayers, by their actions or inactions, can unwittingly grant the IRS more time to do its damage. This occurs, for example, when taxpayers omit or file late international information returns to disclose to the IRS their foreign income, assets, activities and more. Section 6501(c)(8) basically says that, if taxpayers neglect to file certain information returns, then the assessment period never starts to run. This means that the IRS essentially has forever to audit not only the missing information returns, but also items on the related tax returns.
Taxpayers expand the assessment period from three to six years in situations where they omit from their tax returns more than 25 percent of their gross income. This threshold under Section 6501(e) becomes even lower when it comes to unreported foreign income. In such cases, the increase of the assessment period is triggered if taxpayers fail to declare as little as $5,000 of income derived from unreported foreign financial assets.
Finally, according to Section 6663, taxpayers give the IRS forever to audit when they file false or fraudulent tax returns.
The preceding list is not comprehensive, of course, but readers get the idea that assessment periods get longer in various situations because of taxpayer behavior.
Intentionally Giving the IRS More Time
The IRS has declared for years that seeking extensions of assessment periods should be a rarity, not the norm. Revenue Procedure 57-6, published over six decades ago, stated that the IRS has a longstanding policy to ask for extensions only in cases “involving unusual circumstances,” to keep requests “to an absolute minimum,” and to complete all audits within the normal three-year period “whenever possible.” That earlier pronouncement, which the IRS has repeated more recently in its Internal Revenue Manual, seems inconsistent with reality. As anyone who regularly represents taxpayers during IRS audits knows, discussions about Forms 872 happen early and often.
The IRS is required to share certain information with taxpayers when it requests extensions, including their right to limit the amount of time granted, restrict the issues at play, or refuse altogether. Many taxpayers, enlightened about their powers, still agree to give the IRS more time. Why would they do that? Many reasons exist, but only a few are noted here. Some taxpayers hope to conclude matters at the audit stage to dodge costs associated with seeking reconsideration by the Appeals Office or litigating in Tax Court. Other taxpayers, particularly larger companies, want to avoid negative publicity, controversial financial disclosures, and investor unrest. Taxpayers involved in a dispute centered on a pervasive tax issue often have another motive for slowing things down, namely, allowing others with stronger positions and bigger budgets to test the waters first, so to speak. Finally, many taxpayers grant extensions at the end of audits as a condition to getting access to the Appeals Office.
Inconsistent IRS Positions about Resuscitation
The law is surprisingly clear when it comes to extensions of assessment periods for tax issues. The key provision, Section 6501(c)(4), says that the IRS must secure from taxpayers executed Forms 872 or something similar “before the expiration of the time prescribed for the assessment of any tax” and “before the expiration of [any extension] previously agreed upon.” Several Tax Court cases have supported this notion, holding that extensions granted by taxpayers after the fact were invalid. The IRS has confirmed this conclusion in its training materials, too. A recent “Concept Unit” and “Practice Unit” expressly recognize that the assessment period “must still be open when the [Form 872] is executed by both parties” and Form 872 “is an agreement to extend the statute of limitations on assessment, not an agreement to revive an expired statute of limitations.”
Some taxpayers and their advisors are aware of the preceding rules about Forms 872 and tax issues. However, even well-informed individuals might be oblivious to the IRS’s contrary position about FBAR penalty extensions, and rightfully so. This reality is obscure. A news source obtained materials from the IRS about its voluntary disclosure programs thanks to a demand under the Freedom of Information Act. It received, among other things, a document called the Voluntary Disclosure Practice Examiner Guide Paper (“Guide Paper”). The Guide Paper encouraged IRS personnel to obtain from taxpayers the FBAR equivalent of Form 872, which is called the “Consent to Extend the Time to Assess Civil Penalties Provided by 31 U.S.C. 5321 for FBAR Violations” (“FBAR Consent”). Interestingly, the Guide Paper suggested that the assessment period for FBAR penalties “may be extended or waived by the taxpayer after expiration,” it “can be resurrected with taxpayer consent,” and it is a “common law waiver” instead of a statutory waiver like Form 872 pertaining to taxes.
Untested but Dangerous Ground
The IRS’s divergent positions when it comes to Forms 872 for extending assessment periods for taxes, on one hand, and FBAR Consents for foreign account penalties, on the other, is sure to surprise many, and not in a good way. Initial research did identify any cases in which this specific issue has arisen yet, so the question of whether the IRS’s theory about resuscitating “dead” assessment periods can survive judicial review remains unanswered. Until the IRS publicly changes its stance or the courts reject it, taxpayers with potential foreign account problems should be aware of this critical, open issue.