When you think about the statute of limitations, three years is probably what comes to mind. That’s the standard time limit for the IRS to assess and collect a deficiency after you file a return.
But the US tax code contains more than one statute of limitations, as well as related exceptions and extensions.
For example, the three-year period of limitations is extended to six years when you fail to report a “substantial” amount of income.
“Substantial” is defined as 25% of the gross income stated on your return. In computing the amount of gross income omitted, any amounts you disclose in the return, or in a statement attached to the return, in a manner adequate for the IRS to determine the nature and amount of the item are not taken into account (section 6501(e)(1)(A)(ii)).
According to the tax court, “the proper application of the rule is whether an adjustment might be apparent from the face of the return to the elusive ‘reasonable man.’” The court also says you’re not required to disclose the exact amount of the omitted income. However, “[t]he disclosure must be more substantial than providing a clue that would intrigue the likes of Sherlock Holmes but need not recite every underlying fact.”
In T.C. Memo. 2014-131 (Heckman), the taxpayer filed his 2003 personal income tax return on August 15, 2004. He reported $281,378 of gross income, but left off a $137,726 distribution from an employee stock ownership plan (ESOP) to his IRA. He did not explicitly reference the ESOP distribution on his 2003 return or in any attached statement.
The ESOP did not timely file an annual return for 2001, 2002, or 2003. The IRS first became aware of the ESOP and the 2003 distribution to the taxpayer during the course of an unrelated examination in April 2007.
The IRS formally opened an examination of the ESOP in October 2007. At that time, the ESOP filed Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., related to the $137,726 distribution.
In November 2007, the ESOP filed returns for 2001, 2002, and 2003 (using 2006 forms).
On July 30, 2010, more than three years but less than six years after the taxpayer filed his 2003 income tax return, the IRS sent him a notice of deficiency regarding the $137,726 distribution. The IRS said the taxpayer did not adequately disclose the omitted income, so the six year statute applied.
The taxpayer argued that the statements made on other filings, including the ESOP’s returns, should be taken as an ‘adjunct’ to his income tax return, and that those filings provided a “clue” to the existence of the distribution.
Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided to read the entire case.
The taxpayer’s 2003 return does not make any reference to interest in or a distribution or income from the ESOP, and it does not disclose in any manner a distribution or income from or attributable to the ESOP. Nor is there an attachment to the return that does so.
Therefore, his 2003 individual return offers no “clue” as to the existence, nature, or amount of the omitted income. Accordingly, we conclude the taxpayer failed to apprise the IRS of the nature and amount of the omitted income.
We hold the IRS is entitled to the six-year period of limitations pursuant to section 6501(e)(1)(A).