Cheat Sheet on Statute of Limitations
Just like doctors get bombarded with questions like, “Does this look weird to you?” from friends and family, tax professionals are often asked “Can I write this off?”
Recently a friend asked me if she could write off her wardrobe since she needs to look presentable when speaking to groups. No. Disheartened, she asked about the things she does to promote her business like joining organizations, crowd sourcing, webcams for Skyping and subscription fees—yep, those costs are deductible.
We talked further and I was surprised to discover that she didn’t realize that there is a statute of limitations for various tax scenarios. Sometimes, as a tax professional, I take certain things for granted. I’m always surprised to find that what I consider common knowledge is really just another esoteric gem known by only a few.
So here’s a cheat sheet on statute of limitations:
Assessing Taxes. The IRS has three years from the date a tax return is filed to assess the tax. Normally when a return is filed the assessment takes a week or two. However, an additional assessment can occur if a taxpayer’s return is selected for examination--this is why audits are performed within a couple of years of filing.
Sometimes the auditor will ask you to sign a document to extend the statute of limitations. This is done for your convenience to allow you additional time to provide documentation to support the income and deductions that you claimed on the original tax return. It behooves you to sign the document because otherwise they’ll just pick a number any number and you may be facing a big tax bill.
This translates to an open audit period of three years. The IRS will not go back further to audit your tax returns unless they find a substantial error. The agency does have the right to go back six years, but usually no more than that.
The statute of limitations does not apply in the case of a false tax return or fraudulent tax return filed with the IRS with intent to evade any tax.
Claiming Refunds. The three year statute cited above also applies to refunds. So let’s say you neglected to file your 2005 income tax return until a week ago, and after compiling your data, you discover that you are entitled to a big fat refund. Well, guess what? You’re not getting it. Nor will the IRS apply it to any outstanding balances you might have incurred for other tax years. You would have had to file a 2005 tax return by April 15, 2009 (or Oct. 15, 2009 if you had timely filed an extension request before April 15, 2006 when the tax return would have been due). As of this writing, the oldest tax return you could file in order to collect refunds is 2009. And you better do that right away.
Collections. The IRS has 10 years from the date of assessment to collect tax liabilities generated by a tax return. So if you timely filed your 2002 income tax return and you still haven’t paid the balance, the statute will run out this year and you will no longer be obligated to pay the tax liability. But let’s say you filed your 2002 return in 2010--the IRS can attempt collection until 2020. The collection statute can be suspended during certain periods, like criminal proceedings. It normally is not suspended if you are deemed currently not collectable. A couple of my clients have been deemed currently not collectable for years ongoing and have had several years of liabilities drop off.
Payroll Taxes-Civil Penalty. There is a 10-year statute of limitations for civil penalties levied on payroll taxes. Failure to pay payroll tax liabilities can result in a 100% penalty, so don’t mess around with this one unless you are ready to face the scary side of the IRS. Trust fund taxes are the withholdings from an employee’s paycheck. Think about it. Those withholdings are not your money. The employer is required to disburse them to the IRS. In fact, even if you do not disburse them, the employee gets credit for the withholdings. The federal taxes withheld can be claimed on the employee’s income tax return. And his or her social security and Medicare account is credited with those withholdings. The IRS picks up the tab. Payroll taxes cannot be discharged in bankruptcy.