Academic journal article Journal of Accountancy

Gross Income Omissions and the 6 Year Tax Assessment Period: Seemingly Straightforward, the Extended Statute of Limitation Can Be Fraught with Complications

Academic journal article Journal of Accountancy

Gross Income Omissions and the 6 Year Tax Assessment Period: Seemingly Straightforward, the Extended Statute of Limitation Can Be Fraught with Complications

Article excerpt

The general, three-year statute of limitation for the IRS to assess tax is often applied. Far less often, in the case of fraudulent or unfiled tax returns, there is no statute of limitation. In between is the six-year statute of limitation when an item omitted from a return is more than 25% of the gross income stated on the return. Practitioners may encounter such a possibility only infrequently and therefore overlook it. Moreover, as evidenced by case law, the application of the extended statute of limitation is anything but clear-cut.

This article provides insight into how the six-year statute of limitation is applied and discusses what types of omissions trigger it.

THE STATUTORY BACKGROUND

Secs. 6501(a) and (b) provide that, generally, the statute of limitation to assess income tax is three years from the later of the date a tax return is filed or the date the return is due. In addition, Sec. 6501(c) deals with cases where a false return was filed, where there is a willful attempt to evade taxes, or where no return was filed. In these cases, there is no limitation on the time to assess the tax. Also addressed are some specific instances where the limitation period is extended. These include failure to disclose information about listed transactions or certain foreign transactions. These special limitation period extenders are beyond the scope of this article.

Sec. 6501(e)(1) provides that the period for assessment of taxes is extended to six years when there has been an omission from gross income on a return of an amount more than 25% of the gross income stated in the return. Sec. 6501(e)(2) provides a similar rule for omissions from the reportable value of a gross estate or total gifts of items includible on a filed estate or gift tax return, and Sec. 6501(e)(3) provides a similar rule for returns of certain excise taxes. In addition, Sec. 6501(e)(1)(h) extends the period to six years for failure to report specified foreign financial assets whose total value exceeds $5,000.

This article is focused only on omissions from gross income on income tax returns, and the calculation would seem to be straightforward: If gross income reported on a tax return is $100,000, for example, an omission of more than $25,000 will trigger the six-year statute of limitation. However, as seasoned tax practitioners well know, not much in the application of tax law is simple.

MAKING THE CALCULATION

In calculating the percentage of gross income that was omitted, tax practitioners need to remember that there is no line on tax forms for gross income for purposes of Sec. 6501(e), only total income: lines 22, 11,6, and 8 on tax year 2014 individual, corporation, S corporation, and partnership returns, respectively. Gross income will need to be separately determined in accordance with Sec. 61, and issues such as cost of goods sold, property basis, and capital losses will have to be dealt with as discussed below. Gross income might be higher than total income, and this works to the taxpayer's advantage, since a higher denominator would make the omission percentage lower.

INCOME FROM A PASSTHROUGH ENTITY

A question arises about when the statute of limitation starts to run if an individual has income from a passthrough entity. For example, an individual taxpayer might have a different tax year than a passthrough business entity. Maybe the individual filed an extension and the business entity did not, or there could be other due-date timing differences. The rule is generally settled that the limitation period is based on when the individual files his or her own tax returns with the passedthrough items (see, e.g., Bufferd, 506 U.S. 523 (1993)).

APPLICATION OF THE 6-YEAR STATUTE OF LIMITATION

Tax practitioners are well-aware that in the ordinary course of preparing tax returns or advising clients, the decisions they make on how to treat "gray area" or unusual items will affect potential disputes with the IRS. …

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