Civil Tax Arcana Related to Voluntary Disclosure Program (6/29/09)

The expanded FAQs published June 23, 2009 has the following Q&A:

31. How can the IRS propose adjustments to tax for a six-year period without either an agreement from the taxpayer or a statutory exception to the normal three-year statute of limitations for making those adjustments?

Going back six years is part of the resolution offered by the IRS for resolving offshore voluntary disclosures. The taxpayer must agree to assessment of the liabilities for those years in order to get the benefit of the reduced penalty framework. If the taxpayer does not agree to the tax, interest and penalty proposed by the voluntary disclosure examiner, the case will be referred to the field for a complete examination. In that examination, normal statute of limitations rules will apply. If no exception to the normal three-year statute applies, the IRS will only be able to assess tax, penalty and interest for three years. However, if the period of limitations was open because, for example, the IRS can prove a substantial omission of gross income, six years of liability may be assessed. Similarly, if there was a failure to file certain information returns, such as Form 3520 or Form 5471, the statute of limitations will not have begun to run. If the IRS can prove fraud, there is no statute of limitations for assessing tax.

JAT Comments:

1. The question addressed here is the IRS's authority to collect tax beyond if an applicable statute of limitations prohibits the assessment that justifies the collection. For the income tax, penalties and interest (as opposed to the FBAR penalty) under the Areement, Section 6501(a) of the Code unequivocally requires assessment within three years, unless certain exceptions apply. The applicable potential exceptions are (i) the 6 year 25% gross income omission expanding the statute of limitations to year years, and the fraud exception eliminating the statute altogether.

2. If neither of these exceptions apply and depending upon when the taxpayers filed their returns in the early years, some of the early return years statute of limitations is closed depending on when they filed and the IRS is prohibited from making the assessment. If the 6 year statute applies, it would appear that all of the relevant years would be open, provided that the IRS assessed the tax, penalties and interest promptly. And, of course, if the IRS determines there to have been fraud, there is no statute of limitations. We do not understand, however, that, for those participating in the program, the IRS is going to require an admission of fraud nor that they IRS will even make a determination of fraud.

3. In the cases affected (i.e., those where the 3 years statute would otherwise apply), how can the IRS do this? Stated another way, what is to prevent the taxpayer from joining the program and making the payments and then, within the refund period (2 years) seeking a refund? That is the question FAQ 31 answers, albeit cryptically. Basically, the IRS says that it is going to be a settlement, period, in which the taxpayer pays and doesn't get back (in a process similar, I suppose, to the binding effect courts put on Forms 872-AD even where they are not the statutorily authorily authorized closing agreement). By analogy to the Form 872-AD, the agreement is a contract reflecting the parties' bargain, and the parties will be held to the bargain -- the taxpayer pays and does not get back.

4. Focusing on the IRS side of the equation, at least for those taxpayers not subject to the 6 year statute, the IRS has no determination of fraud, so how does it post the payments for the years otherwise barred by the statute of limitations, particularly since the statute is so clear that an assessment outside the normal 3-year period is prohibited absent one of the exceptions. I suppose that the IRS could hold the money in a suspense account and, upon the refund period expiring, move the amount to the excess collections account. Cf ILM 200915034 (3/5/2009), reproduced at 2009 TNT 68-16 (involving the abatement of an erroneous assessment that was beyond the refund limitations period; note that, in this case, the refund limitations period will not have expired upon the payment, but the contract (similar to the Form 872-AD will foreclose the taxpayer from getting a refund, so that ultimately, presumably, barring an assessment, the money would go to the excess collections fund). Another way of solving the problem might be to have the contract say that the IRS potentially had a claim for fraud (which, if sustained would open the statute of limitations and subject the taxpayer to a 75% fraud penalty), but which claim is being settled by the taxpayer agreeing that the statute is open for the assessment and getting the benefit of a 20% penalty rather than a 75% penalty. Either way, taxpayer's entering the program should assume that their payments are gone forever.