If you are facing a tax audit and can legitimately rely on the statute of limitations to avoid the hassle and expense, you should. Why should you prove that you are entitled to a deduction – or find and produce receipts – if it is too late for the government to make a claim? Rules are rules, and the IRS must follow them too, so don’t overlook the importance of the statute of limitations. The main IRS statute of limitations is three years. But the IRS has six years to audit if your return includes a “substantial understatement of income.” Usually, that means you’ve left out more than 25 percent of your gross income. Suppose you earned $ 200,000 but only reported $ 140,000. You missed more than 25%, so you can be audited for six years. But be aware that the IRS could claim that your omission of $ 60,000 was fraudulent. If so, the IRS gets an unlimited number of years to audit.
The IRS also gets six years if you missed more than $ 5,000 in foreign income (for example, interest on a foreign account). If you own part of a foreign corporation, this can trigger additional reporting, including filing a Form 5471. It’s an understatement to say this form is important. Failure to file it means penalties – typically $ 10,000 per form. Worse yet, if you don’t complete the required Form 5471, your entire tax return remains open for review. indefinitely. These are just a few of the 13 IRS statute of limitations rules that everyone should know. What about the Golden State?
Mention taxes, and most people think of the IRS first and foremost. But if you live in California or do business there, even from afar, state taxes are a big chunk of what you pay. California has high tax rates for individuals (13.3%) and businesses (8.84%). Worse yet, a pending tax bill proposes up to a 16.8% state tax rate and a wealth tax. When you add in the state’s notoriously aggressive app and collection, California taxes aren’t negligible. You can say goodbye to California, but you could face a residency audit. Whether you stay or go, how long are you likely to have a Golden State audit? The basic IRS tax statute of limitations is three years in most cases. The California Franchise Tax Board (FTB) administers California income tax, and the FTB has four years to audit, not three. But in some cases, the FTB has unlimited audit time. California, like the IRS, has unlimited time if you never file a tax return. The same goes for false or fraudulent returns.
Suppose an IRS audit changes your tax liability. Maybe you lose your IRS file, or you agree with the IRS during an audit that you owe the IRS a few more dollars. In this case, you are obliged notify California within six months. If you don’t, the California statute of limitations never runs. This means that you could receive an invoice ten years later. So if you settle with the IRS, you should also settle with the FTB. If you are amending your federal income tax return, California requires you to change your California return within six months if the change increases tax owed. If you don’t, the California statute of limitations never expires. There are also other extensions to California’s audit capability. For example, the FTB may send a form asking you to sign it to extend the statute of limitations.
Some taxpayers simply say no, likening the extension request to giving a thief more time to rob your house! But saying no to the IRS or FTB usually triggers an unfavorable assessment, so you usually have to agree to the extension. But you may be able to limit the scope of the extension to certain tax matters, or limit the additional time. What to do if you have a California tax audit first, and by the time it’s resolved, the IRS statute of limitations has expired? Fortunately, with the IRS statute of limitations closed, it’s too late for the IRS to do an audit as well. But it happens the other way around – with the IRS audit first – you’ll also have to pay California if your IRS audit causes you to pay more taxes to the federal government.
With the IRS or the FTB, there is an appeal process. They work the same, but there are differences. After an audit, you can appeal and go through an administrative procedure. If you dispute taxes with the IRS, you can dispute it administratively with the auditor and at the IRS appeals office. If necessary, you can then go to the US Tax Court, where you can dispute the tax before paying. In California, after an audit and an FTB appeal, your next stop would be the California Office of Tax Appeals. There, an administrative judge will hear you and the FTB will plead your case.