Determining the Statute of Limitations in Federal Tax Cases

By Robert H. Breakfield and Charles E. Alvis

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There are two basic statutes of limitation. First is the statute of limitations set forth in IRC section 6501(a), which provides that the IRS has three years to assess an additional tax due. For example, for a taxpayer who filed a 2004 tax return on April 15, 2005, the IRS has until April 15, 2008, to assess an additional tax. This rule has two major exceptions. The three-year statute is extended to six years in a case where the taxpayer has omitted more than 25% of gross income [see IRC section 6501(e)(1)(A)]. Second, there is no statute of limitation in cases where no return has been filed, or where the taxpayer has filed a fraudulent return [see IRC sections 6501(c)(1), 6501(c)(2), and 6501(c)(3)]. These two exceptions permit the IRS to assess an additional tax at any time.

Less understood is the second basic statute of limitations that defines the period of limitation for the collection of the tax. IRC section 6502(a)(1) establishes a statute of limitation collection period of 10 years.

Taxpayers faced with a collection action must know the general rule of limitation and the circumstances when the statute is extended by agreement or by law.

When the Statute Begins to Run

Identifying the date on which the running of the collection statute commences depends upon the date the tax is assessed. (See IRC section 6203 and Treasury Regulations section 301.6203-1.) The assessment of the tax begins with the filing of the tax return, or with the final determination in the examination process. The assessment is not the same as the filing of the return. In the case of a paper return mailed to a service center or an electronically filed return, the assessment occurs when the assessment officer signs Form 23C, Assessment Certificate—Summary Record of Assessment. According to Treasury Regulation 301.6203-1, the assessment shall be made by an assessment officer signing the summary record of assessment. The U.S. Tax Court has upheld the use of computer-generated Revenue Accounting Control Report 006 (Summary Record of Assessment) in lieu of a hand-signed Form 23C [see Thomas W. Roberts v. Comm’r, 118 TC 365 (2002)].

Certain cases involve both an initial assessment and a subsequent assessment [IRC section 6204(a)]. The last assessment of the tax is the commencement date of the 10-year statute period. If a taxpayer files a paper return with the service center on April 15, 2005, the actual assessment of the tax may not occur until June or July 2005, when the assessment entry is made on the IRS’s records (Treasury Regulations section 301.6203-1). If, however, the taxpayer’s return is subject to examination and a subsequent assessment is made, the new period for the 10-year statute will commence with the recording of the second assessment [Treasury Regulations section 301-6502-1(a)(1)]. If the original return was filed with an unpaid balance due and a subsequent examination of the return resulted in a second assessment, then there will be two 10-year statutory periods. The initial balance assessment will start the 10-year statute for the first assessment; the balance due created by the subsequent examination will start the10-year statute for the second assessment.

Precisely when the statute of limitation has commenced can be ascertained from a transcript of the taxpayer’s account, which can be obtained by filing IRS Form 4506-T. The transcript of the taxpayer account will identify the date of all assessments with respect to the tax years at issue. Securing the transcript of account is an essential step to properly verify the time remaining on the collection of statute.

Certain factors stop the statute from running. Factors that interrupt the statute include a taxpayer agreement to suspend the statute, and the operation of law. The following are circumstances under which the taxpayer has agreed to toll the statute.

Form 900 and installment agreement. To avoid enforced collection activity (e.g., a levy against wages or a bank account), a taxpayer may seek administrative relief through the IRS. The IRS has the authority to enter into an installment agreement with a taxpayer, which is a contract whereby the IRS suspends enforced collection action in exchange for the taxpayer’s agreement to make installment payments. The revenue officer has the authority to condition the grant of an installment agreement with the requirement that the taxpayer consent to extend the collection statute of limitation.

The voluntary agreement to extend the statute is memorialized by the execution of IRS Form 900; it is common practice in many IRS offices to make this a condition of the installment agreement. Form 900 provides for the extension of the collection statute to some future specific date and fixes the date of the extension by agreement. The execution of a Form 900 is reflected on the taxpayer’s transcript of account, and constitutes a critical piece of evidence in determining the time remaining under the statute. The American Jobs Creation Act of 2004 amended IRC section 6159 to allow the IRS to enter into installment agreements that will result in only a partial payment of the tax liability before the 10-year statutory period expires; under this new procedure, a revenue officer cannot condition an agreement with a demand to sign Form 900. The IRS website, www.irs.gov, has additional information on the partial-payment option.

Offer in compromise. IRC section 7122 permits the IRS to settle a taxpayer’s liability for less than the balance due. The offer in compromise (OIC) process involves the submission of completed IRS Forms 656, 433A, and 433B, and a $150 user fee mailed to one of the designated OIC units at service centers situated across the country. The statute of limitation for collection is suspended while an offer is considered pending by the IRS (see Form 656).

Rejected offers. The “acceptance for processing” by an OIC unit does not mean that the offer itself is accepted. It merely means that the initial processor has determined that the offer is legally sufficient for further review. Item 8(e) of Form 656 provides that the taxpayer has agreed to the suspension of the remaining time period of the collection statute for the period that the offer is under review. The termination of the review occurs when the taxpayer is informed in writing that the offer has been rejected. The OIC process can take many months. In United States v. Holloway [798 F.2d 175 (6th Cir. 1986); cert. denied, 481 U.S. 1018 (1987)], the taxpayer claimed that his offer was rejected by implication when the IRS referred his case to the U.S. Department of Justice for prosecution. After the offer was formally rejected, the taxpayer found that the statute of limitation for collection had been suspended during the entire period the offer was under consideration [see also United States v. Ressler, 576 F.2d 650 (5th Cir. 1978)].

In Holloway, the taxpayer’s deficiency for the periods 1950 through 1957 and 1960 was finally determined by the U.S. Tax Court on October 30, 1964. On June 18, 1965, the taxpayer filed an OIC pursuant to IRC section 7122. Form 656, signed by the taxpayer, suspended the running of the statute. Subsequently, the IRS reviewed the offer on the following timetable:

• February 3, 1966: The IRS’s Collection division referred the case to the Criminal Investigation Division (CID) special agents for a potential tax-fraud investigation.
• October 18, 1968: The IRS referred the case to the Tax Division of the Department of Justice for reconsideration of tax-fraud prosecution.
• May 20, 1970: The taxpayers were indicted for violation of 18 USC 1001, for knowingly filing a false statement of financial condition. The U.S. District Court dismissed the case for preindictment delay.
• June 12, 1972: The IRS notified the taxpayer that an updated Form 433A (Statement of Financial Conditions) was required for consideration of an OIC.
• February 14, 1973: The IRS formally rejected the OIC for failure to supply updated financial statements.
• September 20, 1976: The U.S. Attorney filed action in the U.S. District Court to reduce to judgment the original 1964 assessment.

In holding that the statutory period was suspended until the OIC was terminated, withdrawn, or formally rejected, the appeal court in Holloway cited Myrick vs. U.S. [296 F2d 312 (5th Cir. 1961)].

In Holloway, the collection statute commenced with the assessment after the final determination of the U.S. Tax Court (October 30, 1964). When the Holloways submitted an OIC on June 18, 1965, only 231 days of the collection statute had run. On February 14, 1973, the IRS rejected the offer. On September 20, 1976, the U.S. Attorney commenced action to reduce the assessment to judgment; therefore, an additional three years, seven months, and six days of the collection statute had run. At the time of the U.S. District Court filing, the statute had run for a total of four years, four months, and 25 days. (In 1976, the collection statute was six years, not 10 years.) What Holloway makes clear is that the mere passing of time does not result in the expiration of the statute of limitations. Although more than 11 years had elapsed, only four years, four months, and 25 days had run against the statute of limitations.

Another lesson from this case is that a taxpayer should acknowledge in writing having been informed of the adverse consequences of suspending the statute of limitation triggered by an OIC.

Accepted offers. In cases where a taxpayer successfully presents an OIC that is accepted by the IRS, taxpayers and their advisors should be cognizant of the collateral terms of the successful offer. Form 656 requires that a taxpayer who has an offer accepted must remain in compliance with all future tax filings for a period of five years, beginning with the calendar year that follows the acceptance of the offer [Item 8(d)]. Form 656 Item 8(N) specifies that failure by the taxpayer to remain in compliance will trigger the default of the offer. Once the IRS notifies the taxpayer that his offer is in default, the IRS may resume collection action for the full amount of the original assessment, plus interest and penalties, less the amount paid toward the original offer. The notification to the taxpayer of the default triggers the resumption of the suspended statute of limitation (see Holloway). Once again, taxpayers and advisors must carefully review Form 656 for a clear understanding of the taxpayer’s obligation under the offer program. The authors recommend that the taxpayer initial each paragraph regarding the conditions set forth on Form 656.

Innocent spouse claims. IRC section 6015 provides remedial benefits to spouses that file joint returns with noncomplying taxpayers. In many collection situations, a tax advisor will be representing an innocent spouse.

When a taxpayer claims innocent spouse benefits, the collection statute is suspended under IRC section 6015 by filing Form 8857. The statute remains suspended until the IRS notifies the taxpayer that the claim has been denied, and for 60 days thereafter.

In each of the above circumstances, the assumption is that the taxpayer has sought remediation from collection activities. As a condition of securing the benefit, the taxpayer may (in the case of a signed Form 900) or must (in the case of an OIC submission or an innocent spouse claim) agree to the extension of the collection statute.

Suspension of the Collection Statute by Operation of Law

Bankruptcy. A petition filed in the U.S. Bankruptcy Court will act to stay IRS collection efforts. The general rule, according to Treasury Regulations section 301.6503(b)-1, is that the collection statute is suspended when the taxpayer’s assets are in the control or custody of any court, such as a typical bankruptcy filing. The collection statute is suspended during the bankruptcy proceedings and for a period of six months after the bankruptcy proceedings have terminated. This suspension applies to assessments of tax and to trust fund recovery penalty cases in which the bankruptcy court cannot discharge the tax or penalty. For example, in a case where the taxpayer has been assessed a 100% penalty for trust fund violations under IRC section 6672, this assessment cannot be discharged in bankruptcy [see 11 USC 507(a)(7)(c) and United States v. Onofre J. Sotelo, 436 U.S. 268 (1978)]. Nor can an assessment of taxes that are less than three years old be eliminated by bankruptcy; nor may assessments that arise from fraud [11 USC. 507(a)(8)(A)(i)]. Therefore, a taxpayer deciding to file a petition for bankruptcy must consider the implications of the suspended collection statute in cases where bankruptcy may be of no help to the taxpayer. When evaluating the time remaining on the collection statute, taxpayers and their advisors should review the transcript of the taxpayer’s account for bankruptcy filings and court conclusion dates.

The expiration of the 10-year collection statute forever bars the IRS from the collection of the tax. Often, tax liens remain filed in the clerk of court’s office in the county of the taxpayer’s residence. The recorded lien can raise issues with land transactions or with refinancing. Assuming that the taxpayer or his advisor has concluded that the statute has expired, the lien is also extinguished [Treasury Regulations section 301.6325-1]. On occasion, title insurance companies, lawyers, or banks want proof that the statute has expired. This information can be obtained from the IRS’s Small Business/Self-Employed Operating Division responsible for the taxpayer’s geographic area. The office that handles this matter is the Centralized Lien Processing unit; information can be accessed through the IRS’s Practitioner Priority Service hotline at 800-860-4259.

Judgment. It is possible for the federal government to extend the collection statute by reducing the assessment to a judgment under IRC section 7403 [United States v. Ettelson (159 F2d 193)].

The IRS may determine that it is likely that the taxpayer has available assets to pay the tax at some point after the statute of limitation for collections has expired. In rare cases, the IRS and the district counsel’s office will refer the matter to the U.S. Attorney’s office. The federal government can proceed to reduce the assessment to a judgment; a judgment in favor of the United States has a 20-year statute of limitation. According to IRC section 6323(f)1 and 2, a judgment lien against a judgment debtor’s real property comes into existence only when a certified copy of the abstract of judgment is properly filed. The federal Fair Debt Collection Practices Act (FDCPA) section 3201(a) requires the filing to be made in the same manner as a notice of tax lien filed under IRC sections 6323(f)(1) and (2). An additional 20-year renewal may be obtained with court approval under 28 USC section 3201(c).