Sam Brotman, JD, LLM, MBA July 20, 2016 11 min read

What is the IRS Statute of Limitations for an Audit?

What is the IRS statute of limitations for an audit?

IRS audits operate under a statute of limitations, meaning the IRS is barred from auditing returns after a set period of time. The limitation period typically begins at a particular time in the process and may be extended according to particular circumstances.

Why do these limitations exist and how do they apply to various audit situations?

The IRS: The Federal Taxing Authority

The Internal Revenue Service, or IRS, is responsible for administering the Internal Revenue Code or the United States Tax code. The agency collects income tax from individuals and businesses that owe payroll and unemployment taxes.

Federal taxes must be paid at the time the money is earned. Businesses do so for their employees by withholding the taxes from wages and remitting them throughout the year. Independent contractors or self-employed individuals remit estimated payments on a quarterly basis.

What Is an Audit?

An audit is a review or examination of individual or business accounts and financial information to ensure information is being reported correctly, according to the tax laws, and to verify the amount of tax reported is substantially correct.

An audit is performed when a questionable return has been discovered, but it is not something that happens immediately after the return is filed. The IRS uses an algorithm to determine which audits require additional scrutiny and are worth auditing. Each return is compared to a norm developed from previous audits or a statistically valid random sample of returns.

Selected returns are not automatically sent for audit. First, a return is reviewed by an experienced auditor who may accept the return as substantially correct. If the auditor finds the return questionable, it is sent to the next stage of the investigation.

An examining group receives the return; the manager of the group reviews it first for issues pertaining to specific industries that operate under special rules, such as construction, farming, and timber.

Again, the return may be accepted, and the review ends, or it is still found questionable. At this point, it is assigned to another auditor for a final review. The return can still be found acceptable, or the taxpayer will be contacted to schedule an appointment.

Types of Audits

Audits can be handled in several ways. The most common is the correspondence audit, which is carried out entirely by postal mail. You may have experienced one without realizing it was an audit.

Another type of audit is the office audit. You will receive a letter asking you to meet an auditor at an IRS office in your area. A field audit takes place at your home or place of business when the auditor anticipates the need for further documentation.

A random audit can be performed as well, but the percentage of taxpayers audited every year is extremely small.

Personal audits take into account personal income tax and any self-employment taxes filed. A business audit will include a review of payroll taxes, employee classification, and excise taxes.

The Audit Process

Audits are initiated by mail or by telephone. The IRS never notifies by email. The person or business being audited receives a written request listing specific required documents to be gathered in preparation.

The IRS accepts some electronic records but will require printed documents as well.

When working with the IRS, taxpayers have a “bill of rights.” You have a right to:

  • Professional and courteous treatment from the IRS
  • Privacy and confidentiality about your tax returns
  • Know why the IRS is asking for information, how the IRS will use it, and what will happen if requested information is not provided
  • Representation by oneself or an authorized representative
  • Appeal disagreements within the IRS and before the courts

The best practice to follow is to answer only the question asked. Do not volunteer information.

There is one of three resolutions at the end of an audit:

  • No change: all items under review were substantiated; no change required.
  • Agreed: the IRS has proposed changes to the return, which the taxpayer understands and agrees with.
  • Disagreed: the IRS has proposed changes, which the taxpayer understands but disagrees with.

If there is a disagreement, you can appeal. The IRS has an independent organization called the Office of Appeals to help taxpayers and the government resolve these types of disagreements. The group does not take sides.

To begin the appeal process, you must submit a formal written protest and represent yourself or be represented by a professional.

What If the Business Is Closed?

Even though your business closed, you must show that all final taxes has been filed, including employer taxes and returns,  employee withholdings, and federal deposits. On the tax return, check the box indicating it is the final return for that entity.

Statute of Limitations

A statute of limitations is a time period established by law to review, analyze, and resolve taxpayer and/or IRS tax related issues. A statute of limitations exists to:

  • Limit the time a taxing organization can assess additional tax
  • Provide adequate alerts and messages to reach field office personnel
  • Minimize the volume of returns to be processed
  • Maintain staffing for timely resolution of cases

The time limit depends on the beginning or end of particular activities and the situation. Also, the states may have different time limits than the IRS.

For filed tax returns, the IRS has three years from the date of filing to determine whether it is a candidate for an audit. If irregularities are found during the audit, the statute doubles to six years. The IRS has a 10 year limit on collections from the date they are assessed.

The State of California has four years from the date of filing and requires an amended return if the IRS makes any adjustments to the federal return. If this does not occur, the statute for the state never expires.

The IRS may request an extension of the statute, which you can refuse; however, the IRS will then make an instant determination based on available information.

There is no time limit for missing tax returns, or if you fail to report certain foreign assets or file a fraudulent return.

Returns with errors or false information would have a six-year limit if you omitted more than 25% of your income or more than $5,000 in foreign income.

How a Tax Professional Can Help

Audits, either personal or business, are stressful situations. An experienced tax professional knows what to expect and what type of information will be requested. Having a representative in front of the IRS can keep you from making mistakes.

A tax professional is also invaluable in the event you must negotiate or settle with the IRS. Offers in Compromise, requests for installment payment agreements, and other processes can be complicated and difficult to perform accurately.

An IRS audit does not need to be a time to fear. A return sent for audit has gone through several gates to reach that point. The IRS does not want to audit unless it is absolutely necessary.

The statute of limitations on audits prevents taxpayers from excessive audits while keeping the IRS adequately staffed.

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Sam Brotman, JD, LLM, MBA

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