Who has the burden of proof on extended assessment periods?


R

Rich Carreiro

This came out of a discussion with someone over how long to
keep returns and backup documentation...

As (layman) I understand it, in the first three years the IRS can
go after a return for any reason. From then to six years, the
IRS can only go after a return if there's an omission of more
than 25% of gross income. And of course at any time (even after
six years) the IRS can go after a return if there is a
false/fraudulent return or a willful attempt to evade tax (all
this from 26 USC 6501).

What I was wondering is where does the burden of proof lie?

Say it's been five years since the return was timely filed. Does
the IRS have to have some sort of "probable cause" (I mean that
sorta metaphorically and not in the literal, criminal procedure
sense) to reopen the return? If so, what sorts of things would
it have to be? And can you challenge the IRS's reopening of the
return and perhaps block the reopening entirely?

Or can they just decide to audit you with no up-front cause to
believe you understated gross income, but regardless of what
other errors, lack of documentation, etc. they find, they can
only assess additional tax if you turned out to have understated
gross income by 25% or more?

Likewise for opening a return after six years. Can they just
reopen a return and go fishing for tax fraud? Or do they have to
have some reason to believe there was tax fraud before they can
reopen the return? And if so, can you try to block them from
even reopening the return?

Note that I'm not talking about real world practice -- I imagine
that due to resource constraints they're not going to reopen an
8-year-old return unless they are pretty confident there is tax
fraud involved -- rather, I'm wondering what the law allows them
to do, whether or not they actually do it.
 
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D

D. Stussy

Rich Carreiro said:
This came out of a discussion with someone over how long to
keep returns and backup documentation...

As (layman) I understand it, in the first three years the IRS can
go after a return for any reason. From then to six years, the
IRS can only go after a return if there's an omission of more
than 25% of gross income. And of course at any time (even after
six years) the IRS can go after a return if there is a
false/fraudulent return or a willful attempt to evade tax (all
this from 26 USC 6501).

What I was wondering is where does the burden of proof lie?

Say it's been five years since the return was timely filed. Does
the IRS have to have some sort of "probable cause" (I mean that
sorta metaphorically and not in the literal, criminal procedure
sense) to reopen the return? If so, what sorts of things would
it have to be? And can you challenge the IRS's reopening of the
return and perhaps block the reopening entirely?

Or can they just decide to audit you with no up-front cause to
believe you understated gross income, but regardless of what
other errors, lack of documentation, etc. they find, they can
only assess additional tax if you turned out to have understated
gross income by 25% or more?

Likewise for opening a return after six years. Can they just
reopen a return and go fishing for tax fraud? Or do they have to
have some reason to believe there was tax fraud before they can
reopen the return? And if so, can you try to block them from
even reopening the return?

Note that I'm not talking about real world practice -- I imagine
that due to resource constraints they're not going to reopen an
8-year-old return unless they are pretty confident there is tax
fraud involved -- rather, I'm wondering what the law allows them
to do, whether or not they actually do it.
The IRS [Commissioner] has the burden of proof for any exception to the
normal 3 year period following the due date. Technically, this includes
late-filed returns (including those on extension), but such is rarely
challenged because a taxpayer often knows he has filed after the original
due date (unless filing of the return was an issue).
 
R

Rich Carreiro

D. Stussy said:
The IRS [Commissioner] has the burden of proof for any exception to the
normal 3 year period following the due date. Technically, this includes
late-filed returns (including those on extension), but such is rarely
challenged because a taxpayer often knows he has filed after the original
due date (unless filing of the return was an issue).
So how does that theoretically work? If someone wanted to hold the IRS's
feet to the fire upon receiving a notice that the IRS plans to re-open
the return, how do they force the IRS to show that it has met the burden
of proof? A court action to attempt to block the re-opening?
 
A

Alan

D. Stussy said:
The IRS [Commissioner] has the burden of proof for any exception to the
normal 3 year period following the due date. Technically, this includes
late-filed returns (including those on extension), but such is rarely
challenged because a taxpayer often knows he has filed after the original
due date (unless filing of the return was an issue).
So how does that theoretically work? If someone wanted to hold the IRS's
feet to the fire upon receiving a notice that the IRS plans to re-open
the return, how do they force the IRS to show that it has met the burden
of proof? A court action to attempt to block the re-opening?
See the following Tax Court case from this month on how one
entity responded in Tax Court when the IRS used the 6 year period
for assessment. This is another case where the IRS has lost the
argument that an overstatement of cost basis represents an
understatement of gross income.

http://www.ustaxcourt.gov/InOpHistoric/CARPENTER.TC.WPD.pdf
 
R

Rich Carreiro

Alan said:
See the following Tax Court case from this month on how one entity
responded in Tax Court when the IRS used the 6 year period for
assessment. This is another case where the IRS has lost the argument
that an overstatement of cost basis represents an understatement of
gross income.

http://www.ustaxcourt.gov/InOpHistoric/CARPENTER.TC.WPD.pdf
That doesn't quite answer my question. In that case the IRS
believed GI was understated by more than 25% and ultimately sent
a final administrative adjustment. The taxpayer challenged the
adjustment, saying it was untimely because they did not understate
GI by more than 25%. But to get to that point the IRS had audited
the return and issued an adjustment.

I'll try to state my question better.

Say I timely file my return. Then five years later the IRS totally
randomly decides to re-open my return. They have no reason whatever
to believe I've understated my gross income at all, let alone by 25%
or more. They've sent me a notice they are going to re-open my return.

Question 1:
At that stage can I go to court and argue "The IRS had no reason
at all to believe I understated my gross income by more than 25%.
Therefore I would like the court to stop this whole IRS action
right now, before it goes any further." ?

Question 2:
If the answer to (1) is "yes", do I have to prove the IRS didn't
meet the belief threshold or does the IRS have to prove it did?
And what is the threshold?

Question 3:
If the answer to (1) is "no", then if the IRS goes on to re-open
my return and finds that I did indeed understate GI by more than
25% and issues me an assessment, can I block the assessment by
going to court and arguing "Yes, I did understate my GI by more
than 25%, but since the IRS had no reason to believe that at the
time they re-opened my return, the 6 year period does not apply and
this assessment is untimely and should be voided." ?

Question 4:
If the answer to (3) is "yes", then again, what's the belief
threshold and who has to prove if it's met or not?

In short, can the IRS go on fishing expeditions after the 3-year
period expires and be able to nail you if your behavior meets one of
the exceptions to the 3-year rule? Or do they have to have some level
of belief you meet an exception (and what's the level and who has to
prove it?) before they can start looking at your return after 3 years?

Again, I imagine that due to resource constraints they would seldom if
ever re-open a return after 3 years unless they actually did have a
high level of belief that one of the exceptions will be met, but I'm
asking about what they are legally allowed to do, not what they do in
practice.
 
A

Alan

That doesn't quite answer my question. In that case the IRS
believed GI was understated by more than 25% and ultimately sent
a final administrative adjustment. The taxpayer challenged the
adjustment, saying it was untimely because they did not understate
GI by more than 25%. But to get to that point the IRS had audited
the return and issued an adjustment.

I'll try to state my question better.

Say I timely file my return. Then five years later the IRS totally
randomly decides to re-open my return. They have no reason whatever
to believe I've understated my gross income at all, let alone by 25%
or more. They've sent me a notice they are going to re-open my return.
I don't believe there is such a thing as "randomly" opening your return
after 5 years. The IRS will open your return after 5 years if it has
reasonable evidence that you failed the 25% test and the 6 year clock is
still open. You are entitled to know why the IRS believes you have
failed the 25% test. I sent you the link, because the respondent upon
being notified by the IRS and obtaining the reason for the assessment
decided to go to Tax Court and ask for a summary judgment rather than
paying the tax and suing in Federal District Court.

Therefore, should the IRS open your return after 5 years, they will
inform you as to why they believe you failed the 25% test. The burden
then falls on to you to disprove it. How you do this depends upon what
evidence they give you.
 
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D

D. Stussy

Alan said:
I don't believe there is such a thing as "randomly" opening your return
after 5 years. The IRS will open your return after 5 years if it has
reasonable evidence that you failed the 25% test and the 6 year clock is
still open. You are entitled to know why the IRS believes you have
failed the 25% test. I sent you the link, because the respondent upon
being notified by the IRS and obtaining the reason for the assessment
decided to go to Tax Court and ask for a summary judgment rather than
paying the tax and suing in Federal District Court.
Certainly not. In order to open such a return, the examining agent must
already have a strong indication that an exception to the normal 3 year
rule applies, and generally, his manager must also sign off on such. When
the audit request is submitted to the computer system, the appropriate
exception's code must be entered else the system should reject the audit as
untimely (at least that's how it worked under "AIMS" used in the 1990's by
the IRS).
Therefore, should the IRS open your return after 5 years, they will
inform you as to why they believe you failed the 25% test. The burden
then falls on to you to disprove it. How you do this depends upon what
evidence they give you.
No. Opening an examination does not grant Tax Court jurisdiction. The IRS
must propose a deficiency first (on a 90-day letter).

Yes, you are free to raise that the 25% gross omission exception does not
apply. That is what was done on the recent case cited in this thread.

You do. In the tax Court, the taxpayer is the petitioner.

No fishing.

During my IRS career, I only saw this issue once in six years. It was for
a "private loan" where one taxpayer deducted $13k of interest expense (and
another 25% of it for "home office" EBE as "rent," or 125% in total), and
the other taxpayer whose return I pulled for comparison reported ZERO for
interest and had no Schedule E, plus $10k of other unreported income per
1099's. This second taxpayer's return was opened on the 25% gross omission
issue.

As I was reassigned before the audit interview, I can't say how it came
out. However, either way as rent or as interest, it was income that
yielded a tax.
 

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