We previously provided an overview of the time limits imposed on the Internal Revenue Service (IRS) for assessing federal tax. The general rule is that the IRS must assess tax within three years from the later of the due date of the original tax return or the date it was filed. If the IRS does not assess tax during this period, it is foreclosed from doing so in the future. Note that the filing of an amended return does not restart or extend the limitations period. There are numerous exceptions to this rule, including if there is a substantial omission of income, fraud, failure to file a return, extension by agreement and failure to provide certain information regarding foreign transactions. We discussed many of these exceptions in Seeking Closure on Tax Positions: A Look at Tax Statutes of Limitation and Omitted Subpart F and GILTI Income May Be a Statute of Limitations Trap for the Unwary. Below, we discuss the rules and considerations for consenting to extending the time to assess federal tax.
Internal Revenue Code (Code) Section 6501(c)(4) provides that, except in the case of estate taxes, taxpayers (or their duly authorized representative) and the IRS may consent in writing to an extension of the limitations period for assessment. Importantly, such an agreement must be executed before the limitations period expires. In other words, assuming no other exception applies to the general three-year rule, an agreement to extend the limitations must be executed within the later of three years from the date the tax return was due or filed. If executed after that date, the consent is invalid. Thus, a late-filed consent cannot revive an otherwise closed limitations period. Under Code Section 6511(c), extending the statute of limitations on assessment also extends the period for filing a claim for credit or refund to six months after the expiration of the extended assessment period.
Form 872, Consent to Extend the Time to Assess Tax, is generally used to effectuate an agreed extension to a certain date, however, other versions of the form may be used for different types of taxpayers or issues (e.g., Form 872-M, Consent to Extend the Time to Make Partnership Adjustments, is used for partners subject to the centralized partnership audit regime under the Bipartisan Budget Act of 2015). Form 872-A, Special Consent to Extend the Time to Assess Tax, may be used to extend the limitations period for an indefinite period (referred to as an Open-Ended Consent). An Open-Ended Consent ends 90 days after the mailing by the IRS of written notification of termination or receipt by the IRS of written notification of termination from the taxpayer (both actions are accomplished through the use of Form 872-T, Notice of Termination of Special Consent to Extend the Time to Assess Tax), or the mailing of a notice of deficiency. The IRS’s views on Open-Ended Consents are summarized in Rev. Proc. 79-22, 1979-1 C.B. 563. Open-Ended Consents are rarely used and such a consent request from the IRS must be carefully considered.
For many taxpayers, three years may seem like more than enough time for the IRS to audit a return. Indeed, the Internal Revenue Manual (IRM) 126.96.36.199 and Rev. Proc. 57-6, 1957-1 C.B. 729 provide that consent to extend the assessment period should be sought in cases “involving unusual circumstances.” That is generally true for most individual taxpayers and simple audits.
However, for large corporate taxpayers, complex partnerships and high-net-worth individuals, it is common for the limitations period to be extended by agreement. Audits of these types of taxpayers often span several years and involve complex tax return issue, and the IRS simply does not have the time or resources to complete the audit process within the normal three-year period.
The IRS has certain guidelines it follows for when it will request an extension. Common examples include:
- There must be at least 180 days left on the limitations period if the examination is ongoing and additional time is needed to complete the examination process, as well as the administrative processing of the case (300 days for taxpayers in the Large Corporation Compliance or Industry Case Programs). Thus, the IRS generally begins to seek an extension weeks or months in advance of this date.
- There must be at least 12 months left on the limitations period before a case will be sent to the IRS Independent Office of Appeals (IRS Appeals).
- There must be at least 395 days left on the limitations period if the case is received by Technical Services.
- There must be at least 12 months left on the limitations period if the case is sent to a Joint Committee reviewer and at least six months left from the date a report is transmitted to the Joint Committee program manager.
Another common situation where the IRS seeks an extension is when there are multiple years included in an audit cycle. In that scenario, we typically see the IRS request an extension of the limitations period for the earlier years so that the expiration dates for all years in the cycle align with the limitations period for the latest year under examination.
Taxpayers are not required to extend the limitations period, and the IRS is statutorily required to notify taxpayers of their rights to refuse, to request that the extension be limited to particular issues and to request that the extension be limited to a certain date (the latter is referred to as a Restricted Consent). The IRM provides that the IRS “will” agree to a Restricted Consent if five conditions are met (subject to certain exceptions, such as a case that will require review by the Joint Committee on Taxation). In our experience, the IRS is hesitant to agree to a Restricted Consent except in rare situations. This is illustrated by the IRM’s statement that such consents “will be discouraged, if possible, until the examination is completed to the extent that all potential issues have been identified.”
Refusing to extend the limitations period may result in adverse consequences for the taxpayer. For example, the IRS may propose adjustments on issues that are not fully developed and issue a notice of deficiency to the taxpayer that requires them to either initiate litigation in the US Tax Court or pay the additional proposed tax and seek a refund. Penalties may also be asserted when the taxpayer might otherwise be able to demonstrate that an applicable defense applies. Thus, taxpayers often have little leverage when it comes to pushing back on a consent request.
This does not mean that taxpayers should blindly agree to any extension request made by the IRS. In exchange for consenting to an extension, taxpayers may want to seek assurances from the IRS as to the remaining steps and timeline for the audit to put pressure on the IRS to complete the examination in a timely manner. Additionally, we have had success in getting the IRS to agree to shorter or rolling extensions (e.g., three or six months) with the understanding that future consents may be granted if the IRS demonstrates that the audit is proceeding in a timely and efficient manner.
Moreover, in certain circumstances, taxpayers may decide not to extend the limitations period. As noted above, this requires the IRS to make the decision as to whether to close the audit without any adjustments or issue a notice of deficiency. The decision not to extend may be based on several considerations, including not wanting the IRS to potentially discover other issues not previously identified, locking the IRS into a specific position (i.e., the taxpayer may believe that the IRS’s position is weak or unsupportable), wanting to get the issue in front of the Tax Court or IRS Appeals through the post-docketing Appeals process or believing that further discussions with the examination team or IRS Appeals would not lead to an acceptable outcome. In rare situations, we have seen the IRS decline to propose any adjustments and close the examination without issuing a notice of deficiency.
In situations where the IRS determines that there is a deficiency in income tax (i.e., the tax determined by the IRS is more than the tax shown on the tax return), it generally must follow the deficiency procedures before it can assess any additional tax. Exceptions exist in certain situations, such as mathematical or clerical errors and tentative carryback or refund adjustments. Compliance with these procedures requires the issuance of a notice of deficiency under Code Section 6212, which provides the taxpayer with the opportunity under Code Section 6213 to file a petition to the Tax Court within 90 days (150 days if the notice is addressed to a person outside the United States). Under Code Section 6503(a), the issuance of a notice of deficiency suspends the limitations period during the 90- or 150-day period in which the taxpayer is permitted to file a petition. If a petition is filed, such suspension remains in effect for 60 days after a Tax Court decision becomes final.
Practice Point: Requests for extensions of the statute of limitations on assessment must be carefully considered. Agree to an extension and for how long is typically a strategic decision. Although granting an extension may be inevitable for most taxpayers (particularly large corporate taxpayers), to avoid litigation and preserve the ability to obtain a settlement at the administrative level taxpayers should consider seeking assurances from the IRS on the matters discussed above in exchange for agreeing to a reasonable extension. For example, get assurance that the issues identified at the time of the extension request are the only issues that the IRS will be examining.