What are the statute of limitations on an IRS audit and a California tax audit? There is a time limit, known as the “statute of limitations“, when the IRS and/or California must complete an audit of your tax returns. It is important to understand the concept of the statute of limitations, especially from the perspective of an audit or failure to file an income tax return.
The statute of limitations is the length of time the IRS (or the State of California) which the law has established for the tax agency to review, analyze, audit and ultimate resolve tax issues associated with a return. The statute of limitations period begins on the date a tax return was filed. It is important to note, therefore, that the failure to file a tax return means there is no statute of limitations on the ability of the IRS or the State of California to go back in time during an audit.
There is no statute of limitations on an IRS audit and a California tax audit in cases involving civil or criminal tax fraud.
IRS Statute of Limitations
The IRS statute of limitations is usually based on a 3 year period from the date you originally filed the return. While there are other issues that can extend that period, in most cases the 3-year statute applies. The statute of limitations is extended to six years if the IRS believes there could be significant and substantial errors, fraud, or cases where the US taxpayer under-reported their income by more than 25%.
It is important to understand the statute of limitations on an IRS audit as you enter the process. Many unrepresented (and unknowing) US taxpayers are in the middle of an audit when they get a letter from the IRS asking to extend the statute of limitations in their case. This is a critical point of negotiation and should not simply be signed and returned.
During an IRS audit, every important detail and figure must be a part of the “record” prior to the “Notice of Determination” at the end of the audit. Many audit results are substantially reduced on appeal, but the appeal is entirely based upon the “record” established during the audit. You cannot add a single piece of data once the notice of determination is issued.
How does this relate to the statute of limitations on an IRS audit? If we have provided all of the critical information for our clients, and the IRS is dragging its feet we may choose to let the statute of limitations expire or deny their request to extend it forcing them to complete the audit. In some cases, we are still working to get additional information into the file or are negotiating (or arguing) some point of law or accounting with the auditor. In those cases, it may be in our client’s best interest to extend the statute.
You should never face the IRS alone, especially in an audit. It may surprise you to learn it is never in a taxpayer’s interest to speak with the IRS directly. Your tax attorney should manage all communications with the IRS. Most clients are relieved to know they will not have to worry about the pressure or risk of these conversations.
California Statute of Limitations
What is the statute of limitations for a California tax audit and how is that different from the federal regulations and laws?
The Franchise Tax Board or FTB, California’s income tax agency, has four years from the date of filing to complete an audit. This is strategically important as it provides the FTB with an extra year to see if anything happens with the IRS. It is well known that the agencies communicate with one another, and a change order in one audit is very likely to result in a knock on the door from the other agency. Like the federal law, California law extends the statute of limitations indefinitely in the event of a failure to file a tax return or if income or other financial information is substantially misrepresented or fraudulent within a California tax return.
It is absolutely possible to agree to waive the statute of limitations in a State of California or FTB tax audit, and in some cases this is in our client’s interests. In many cases we need to ensure that the “file” in your case has all of the information necessary to ensure a rightful determination resulting in the lowest possible finding or a “zero additional tax” decision.
However, this is not a strategy to avoid paying additional taxes to California if and when the IRS issues a Notice of Determination declaring you owe additional taxes. Californians are required by law to notify the FTB within six months of an IRS Notice of Determination – even if the date of the IRS action has passed the 4 year statute of limitations established by California law. You will in all likelihood be required to pay additional taxes to the FTB if the IRS Notice of Determination increased your tax obligations at a federal level.
The failure to provide this notification to the FTB results in the suspension of the statute of limitations for a California tax audit indefinitely. Its also interesting to note that you are actually more likely to be audited by the FTB than by the IRS at this point in time. The only good news for California income taxpayers is when an FTB audit passes the three year federal statute of limitations, the IRS cannot come back on you (except in cases of fraud or under-reporting of income by more than 25%).
IRS audits and FTB audits are quite painful for most taxpayers. If you are concerned about the statute of limitations on an IRS audit and a California tax audit or have received notification of an IRS audit or FTB audit we invite you to download our free white paper “What to Expect from an IRS Audit” (helpful information for California audit targets as well), learn more about the integrated tax, legal, accounting and business consulting services of Allen Barron and contact us or call today to schedule a free consultation at 866-631-3470.
