In the realm of tax law, the statute of limitations is not new territory. You know the general rule: the statue of limitations for assessment of taxes expires three years from the due date of the return or the date filed, whichever is later (section 6501).
Where taxpayers—and sometimes the IRS—may go off course is when to begin the journey. That is, what sets the three year measurement period in motion?
The first step is to define what a return is. Section 6501 defines a “return” as “the return required to be filed by the taxpayer.” In general, that means when you have gross income that equals or exceeds the exemption amount, you must file a federal tax return.
Next, you have to properly file a tax return. Without a filed return, the statute of limitations doesn’t start at all.
Beyond the mere act of filing, “properly” means the return must be valid. The court uses a four part test to determine whether returns are valid. The requirements are that a return has to contain sufficient data to calculate tax liability, purport to be a return, be an honest and reasonable attempt to satisfy the requirements of the tax law, and be executed under penalties of perjury.
In addition, “properly filed” means the return must be filed where the code or regulations require it to be filed (section 6091). Filing in the wrong place generally does not constitute “filing” for purposes of starting the statute of limitations.
In 144 T.C. No. 5 (Sanders), the question was whether returns filed by the taxpayer in the US Virgin Islands met his federal tax filing obligations and so started the statute of limitations.
The US Virgin Islands are an unincorporated territory of the United States, and the tax system “mirrors” the US revenue code by substituting “Virgin Islands” for “United States” throughout. The income tax forms are the same.
The filing instructions differ depending on whether taxpayers are bona fide residents of the Virgin Islands or nonpermanent residents. Bona fide residents file returns with the Virgin Islands Bureau of Internal Revenue. Nonpermanent residents file returns with both the Virgin Islands BIR and the US Internal Revenue Service.
In this case, the taxpayer hired a CPA in the US Virgin Islands and consulted with a tax attorney there. He signed and filed Forms 1040 with the Virgin Islands BIR for tax years 2002-04. The returns were filed on October 15, 2003, October 15, 2004, and December 15, 2005, respectively. Because he considered himself a resident of the US Virgin Islands, he filed the returns with the Virgin Islands BIR only.
In 2010, the IRS determined the taxpayer was not a bona fide resident of the US Virgin Islands for tax years 2002-2004 and issued a notice of deficiency.
The taxpayer said the statute of limitations for those years had expired in 2008 and it was too late for the IRS to assess tax.
The IRS argued the statute had not expired because the taxpayer did not properly file US income tax returns as required of nonpermanent residents of the US Virgin Islands.
The court decided the taxpayer was a bona fide resident of the US Virgin Islands.
To answer the question of whether the returns were sufficient to start the statute of limitations, the court also considered whether they were valid.
What do you think?
Did the returns meet the four requirements of valid returns?
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THE COURT’S DECISION
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The taxpayer hired a CPA located in the Virgin Islands to prepare the Forms 1040 that he filed with the Virgin Islands BIR for tax years 2002-04. These returns contained more than sufficient data to calculate his tax liabilities. Both the IRS and the Virgin Islands BIR required the use of this form for income tax filing.
The forms purport to be returns. Not only did the taxpayer hire a CPA to prepare his returns; he also consulted with an established tax attorney in the Virgin Islands.
The taxpayer’s tax returns for tax years 2002-04 were an honest and reasonable attempt to satisfy the requirements of the law. The tax returns filed were consistent with the requirement of section 932(c)(4) and the IRS instructions for US Virgin Island taxpayers.
The taxpayer signed each tax return under penalties of perjury.
The taxpayer’s tax returns for tax years 2002-04 meet the requirements, and therefore the returns filed were the required returns for purposes of section 6501(a).
We conclude the taxpayer has proven that the section 6501(a) period of limitations on assessment expired before the date the IRS mailed the notice of deficiency.