Failure to File Required International Information Return Suspends Statute of Limitations on Entire Return until the Information Return is Filed

Under section 6501(a) of the Internal Revenue Code (Tax Code) and section 301.6501(a)-1(a) of the Income Tax Regulations (Tax Regulations), the IRS is required to assess tax within 3 years after the tax return was filed. This means that, unless special circumstances apply, the IRS must assess a new tax as the result of an audit within 3 years of the return being filed.
Under section 6501(e) of the Tax Code and section 301.6501(e)-1 of the Tax Regulations the statute of limitations is 6 years if the taxpayer omits additional gross income in excess of 25% of the amount of gross income stated in the tax return filed with the IRS. This is known as the substantial understatement assessment period because it comes in when the taxpayer understates their income by 25% or more on the return. It’s also doubled if you omitted more than $5,000 of foreign income.
We all know that the statute of limitations on assessment will not begin to run until a taxpayer files a return, and the statute of limitations on collection will not begin to run until the IRS makes an assessment. IRC § 6501(c)(3).

A similar rule applies where a taxpayer fails to file required international information returns. Section 6501(c)(8) provides:

In the case of any information which is required to be reported to the Secretary pursuant to an election under section 1295(b) or under section 1298(f), 6038, 6038A, 6038B, 6038D, 6046, 6046A, or 6048, the time for assessment of any tax imposed by this title with respect to any tax return, event, or period to which such information relates shall not expire before the date which is 3 years after the date on which the Secretary is furnished the information required to be reported under such section.

Thus, if a taxpayer is required to report on interests in, control over, transfers to, or distributions from foreign accounts, corporations, partnerships, entities or trusts (as provided for in the above-listed sections), the three-year statute of limitations will not start running until the taxpayer submits that foreign information report to the IRS.

And, since March 2010, the extended limitations period generally applies to the entire return applicable to that Taxpayer, not simply to the liabilities associated with the information that was not filed.  See Pub. L. 111-147, § 513(b); I.R.M. 4.61.2.3 (05-01-2006). Prior to amendment, a taxpayer’s failure to comply with reporting obligations under Sections 1295(b), 1298(f), 6038, 6038A, 6038B, 6038D, 6046, 6046A, or 6048, only extended the statute limitations with respect to that specific issue.  Now, a taxpayer’s failure to file an informational return regarding, for example, a foreign asset or cross-border transaction, will expose the taxpayer’s entire tax year to an extended statute of limitations for evaluation and assessment, even if the Form 1040 tax return was timely filed. This rule applies to tax returns filed after March 18, 2010, as well as returns for which the statute of limitations had not yet expired as of March 18, 2010.

Reasonable cause provides an exception to the “entire return” rule. Otherwise stated, if the taxpayer can establish that his failure to file a required foreign information return is due to reasonable cause (and not willful neglect), then the extended limitations period only applies to “related items.”  Related items include:

(1) adjustments made to the tax consequences claimed on the return with respect to the transaction that was the subject of the information return, (2) adjustments to any item to the extent the item is affected by the transaction even if it is otherwise unrelated to the transaction, and (3) interest and penalties that are related to the transaction or the adjustments made to the tax consequences.

Staff of Joint Comm. on Taxation, 111th Cong., Technical Explanation of the Revenue Provisions of the Senate Amendment to the House Amendment to the Senate Amendment to H.R. 1586, Scheduled for Consideration by the House of Representatives on August 10, 2010, 37 (2010) [hereinafter “Technical Explanation”].

For example, the IRS generally has three years, until March 31, 2014, to review and assess tax with respect to a tax return filed on March 31, 2011. However, if that taxpayer failed to file a necessary foreign information return for that tax year, the limitations period will not begin to run until the missing information return is filed.  If the missing report is filed on June 1, 2013, the limitations period will run until June 1, 2016.  During that time, every item related to that tax year will be subject to examination and assessment, unless the taxpayer can show reasonable cause for failing to file the foreign informational return.  If the taxpayer does establish reasonable cause, between March 31, 2014, (after the initial statute of limitations runs) and June 1, 2016, the IRS can only make adjustments related to the foreign informational return.  See Technical Explanation at 37.

Section 6501(c)(8) has made it even more imperative that taxpayers take care to comply with each and every filing obligation with respect to foreign assets and cross-border transactions. Timely filing of accurate foreign information returns will trigger the running of the statute of limitations, not only on those forms, but on the taxpayer’s entire tax year.  If the IRS should discover an unreported financial asset, the taxpayer’s entire tax return, and thus tax liability, is open for assessment.

 A taxpayer may file a claim for a tax refund of an overpayment of any tax within 3 years from the time the tax return was filed with the IRS or 2 years from the time the tax was paid to the IRS, whichever period is the longer. If no tax return was filed with the IRS, the claim may be made within 2 years from the date that the tax was paid to the IRS. See section 6511(a) of the Tax Code.