Statute Mitigation 26 USC 1311-1314 There’s generally a three, sometimes six, year statute of limitations on each tax return. The “statute” starts from the date the return was filed. A tax return year whose statute of limitations has expired is hereafter referred to as a Closed year or Closed tax year. Conversely, a tax return year within its three or six year window is hereafter referred to as an Open year or Open tax year. The issue in some audits is the proper year in which to include or exclude a transaction(s). For example, a transaction that should have been included or excluded in the year being examined was erroneously included or excluded in another year. If the other year is Closed, 26 USC 1311- 1314 may allow that Closed year to be Opened and adjusted to correct the error. “Another year” as used above is usually a year previous to the year being examined. However, if the case takes a long time to get through the courts, “another year” could be a year subsequent to the year being examined. “Another year” is usually a Closed year or a year that Closed during the course of the examination. The objective of 26 USC 1311- 1314 is to disregard the statute of limitations when the correction of an error(s) required by a “Determination” would impact a Closed year. A “Determination”, in some cases, may be made by a Court or it could be the results of a Settlement Agreement between the IRS and the Taxpayer. The process is sometimes referred to as “Statute Mitigation.” In order to mitigate the statute of limitations there generally must be -- (a) A Determination, (b) specific circumstances of adjustment, and one of three conditions, (c) an “inconsistent position”, (d) the correction was not barred at time of erroneous action, and (e) the existence of relationship (outside the scope of this review). Not all conditions apply to each circumstance. (a) A “determination”, in most cases is a court decision or a settlement agreement between the Taxpayer and the IRS. A more complete definition of a “determination” is in 26 USC 1313. Therefore, if an examination just started, it would not qualify for Statute Mitigation at that time. However, if, aside from the issuance of a “determination”, Statute Mitigation would apply, its probability could be raised during the discussion of potential audit adjustments. Further, if there’s a potential adjustment that could carry back to another year that is not under audit, and the statute of that year is not barred; a “protective claim” could be filed on that year before its statute of limitations expires. (The filing of a protective claim is outside the scope of this article). (b) The specific “circumstances” of adjustment, cited in 26 USC 1312, are -- (1) Double inclusion of an item of gross income (2) Double allowance of a deduction or credit (3) Double exclusion of an item of gross income – (A) Items included in income or (B) Items not included in income (4) Double disallowance of a deduction or credit (5) Correlative deductions and inclusions for trusts or estates and legatees, beneficiaries, or heirs (outside the scope of this review) (6) Correlative deductions and credits for certain related corporations (7) Basis of property after erroneous treatment of a prior transaction Note: For illustrative purposes it’s assumed that the transactions at issue were included or excluded from the taxpayer’s own return. However, the rules under 26 USC 1311-1314 also pertain to related parties or returns. In addition, 26 USC 1312(7), Basis of property after erroneous treatment of a prior transaction, allows an adjustment to unrelated returns under certain conditions; see Treasury Regulations 26 CFR 1.1312-7 for additional detail. (c) An “Inconsistent position” is needed on the part of the Taxpayer or the Government when the “circumstance” of adjustment falls under 26 USC 1312(1), (2), (3) (A), (5), (6) and (7), summarized in (b) above. The Government takes an “inconsistent position” when it successfully argues that an item of income should be included in the tax year being examined and such position is “inconsistent” with the way that item of income was handled in another year. If a refund or credit would result from the correction of the error in the Closed year, that year is Opened so that the Taxpayer can receive the credit or refund. This rule is in 26 USC § 1311(b) (1) (A) and is very specific; it only works if the Commissioner (IRS) is taking the inconsistent position. [Treasury Regulations 26 CFR 1.1311(a)-1(b)]. Example: Borrowed from 26 CFR 1.1311(b)-1(b)(1) A cash basis Taxpayer erroneously accrues interest income on his 2008 return. The Taxpayer actually receives the interest in 2012. In 2012, the statute on the 2008 return is Closed. The IRS audits the 2012 return and determines that since the Taxpayer is on the cash basis of accounting the interest should be reported on the 2012 return (the year received). Since the Taxpayer had included the interest in the 2008 return, a Closed year, the Government has taken an inconsistent position. If the Taxpayer and the IRS enter into a closing agreement (a “determination” defined by 26 USC 1313) the 2008 return can be opened and adjusted in the Taxpayer’s favor. The Taxpayer takes an “inconsistent position” if he deducted an item in another year which is now Closed and he successfully contends that the item should be deducted in the year being examined. If an additional assessment would result from the correction of the error in the closed year, then that year is Opened so that the Taxpayer can pay the additional tax due. This rule is in 26 USC § 1311(b)(1)(B) and is restricted to cases where the Taxpayer is taking the inconsistent position. [Treasury Regulations 26 CFR 1.1311(a)-1(b)]. Example: Borrowed from 26 CFR 1.1311(b)-1(c)(1) A Taxpayer claimed a deduction for a loss arising from a casualty on his 2008 return. The 2008 return was not audited, it was timely filed and the statute of limitations expired 4/15/2012. On 5/1/2012 the Taxpayer discovered that the casualty loss claimed in 2008 really belonged on the 2009 return. The 2009 return was timely filed on 4/15/2010 and its statute was open on 5/1/2012. At that time the Taxpayer filed a claim for refund on the 2009 return and deducted the casualty loss on that return. The IRS reviewed the claim on the 2009 return and agreed that the casualty loss belonged on the 2009 return. By claiming that the loss belonged on the 2009 return the Taxpayer has taken an inconsistent position with what he claimed on the 2008 return. Consequently the 2008 return can be opened and casualty loss claimed that year adjusted in the Government’s favor (assuming there’s a “determination”). Treasury Regulations 26 CFR 1.1311(b)-1 have detailed samples on “inconsistent” positions. (d) The correction was not barred at time of erroneous action . Meaning; the statute of limitations on another tax year, affected by the position taken in the year being audited, was open when the IRS or Taxpayer first maintained their position in the year audited. It’s possible for another year return to be Open and then Closed during the examination of a subsequent year. For example, assume the 2010 return is filed on 4/15/2011, its statute expires 4/15/2014. A few years later the 2012 return is filed on 4/15/2013. The 2010 return will be Open when the 2012 return is filed. If the 2012 return is audited on 1/1/2014 the 2010 return will be Open for a few months but will be Closed by 4/15/2014. This may create a problem if after 4/15/2014 the IRS disallows a deduction claimed on the 2012 return but which could have been claimed on the 2010 return. Remember from above that the IRS “inconsistent position” rule only applies when the IRS is proposing the inclusion of an item of income in the audit year, and not to an IRS disallowance of a deduction in the audit year. That’s when 26 USC 1312(4) may apply. There are two exceptions to the requirement that either the Taxpayer or Government must take an inconsistent position before the statute of limitations may be mitigated under 26 USC 1311-1314. [1] Double Exclusion of an Item of Gross Income [26 USC 1312(3) (B)] The first exception to the “inconsistent position” rule is where the Government includes an item of income in the current year (year under audit) but the “determination” (i.e. Tax Court ruling or settlement agreement) is that the item actually should be included in another year; and the other year is Closed when the “determination” is made. Under this rule, the item excluded from gross income in the current year can be included in the prior Closed year. In order for this rule to apply though, the other year had to be Open when the IRS “first maintained, in a notice of deficiency” or before Tax Court they wanted to include the item of Gross Income in the year being examined. [Treasury Regulations 1.1311(b)-2(a)] Example: Using the above 2010 and 2012 returns. Assume the taxpayer is on the accrual basis of accounting and should have accrued payments for services performed in 2010. He fails to include the income on the 2010 return and on the 2011 and 2012 returns. The cash payment is received in 2012. On 1/1/2014 the IRS examines the 2012 return. At that point the 2010 return is still open since, as noted above, its statute doesn’t expire until 4/15/2014. On 4/14/2014 the IRS hand delivers the taxpayer a statutory notice of deficiency. That notice increases the 2012 return’s gross income by the cash payment received in 2012. Taxpayer appeals to Tax Court claiming that he’s on the accrual basis of accounting and the services were performed in 2010 and the income should have been included in the 2010 return. In 2014 the Tax Court rules in the taxpayer’s favor, the income belongs in 2010 not 2012. By that time, the 2010 year is Closed. However, because the 2010 year was Open when the IRS delivered the statutory notice of deficiency on 4/14/2014, USC 1312(3) (B) applies. The Court could then authorize the opening of the 2010 return and apply the item of gross income to that year. Note that if the Government had issued the statutory of deficiency a few days later, this rule would not apply. Additional detail examples relating to 26 USC 1312(3) (B) are in Treasury Regulations 1.1312-3(b). Note USC 1312(3) (B) only applies if the taxpayer had not included the item of gross income at issue in another return. If the item was claimed on another year’s return USC 1312(3) (A) might apply. [2] Double Disallowance of Deduction or Credit [26 USC 1312(4)] The second exception is where the Government disallows a credit or deduction in the year under audit, and that disallowance would have allowed a credit or refund in another year that is Closed, at the time the determination is made (i.e., Tax Court ruling or settlement agreement). The statute of the other year will be re-opened if that other year was Open when the Taxpayer “first maintained in writing before the Commissioner or the Tax Court that he was entitled to such deduction or credit for the taxable year to which the determination relates.” [Treasury Regulations 1.1311(b)-2(b)] Those same regulations define “first maintained in writing” as “when he first formally asserts his right to such deduction or credit as, for example, in a return, in a claim for refund, or in a petition (or an amended petition) before the Tax Court.” Example: Using the above 2010 and 2012 returns. Assume the taxpayer is on the accrual basis of accounting and could have accrued an expense on the 2010 return. The statute on that return, as noted above, expires 4/15/2014. The Taxpayer forgot to accrue the expense on the 2010 return but instead claimed it on the 2012 return (he paid the liability in 2012). The IRS audits the 2012 return and challenges the deduction. The taxpayer appeals and in 2016 the Tax Court agrees with the IRS that the deduction belonged in 2010 and not 2012. Because the 2010 return was Open when the Taxpayer filed his 2012 return (4/15/2013), it was open “when he first formally asserts his right to such deduction.” Consequently, Tax Court could re-open the 2010 return and apply his 2012 deduction to that year. Notice that “maintaining a position in writing” is the filing of a return by the taxpayer and the issuance of a statutory notice of deficiency by the Government (basically the conclusions of an examination) The Government’s issuance of a notice of proposed adjustment during the course of an examination is not “maintaining a position in writing” for this rule. Additional detailed examples at Treasury Regulations, 26 CFR 1.1312-4. Summary The statute of limitations may be mitigated under seven specific circumstances and three conditions. This would be required if it’s determined that a transaction was included or excluded from the year under audit but should have been correctly reported in another year and the statute of limitation for the other year has expired. The circumstances are specified in 26 USC 1312. The two conditions covered in this article are: (i) the taking of an inconsistent position by either the Government or Taxpayer and (ii) the correction was not barred at time of erroneous action. The former condition applies to the circumstances described in 26 USC 1312(1), (2), (3) (A), (5), (6) and (7). The latter applies to the circumstances described in 26 USC 1312(3) (B) and (4). Link to PDF file. https://titles26and31-public.sharepoint/siteassets/MitigatingStatuteofLimitations.pdf
Posted on: Thu, 24 Oct 2013 12:08:10 +0000
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