Most taxpayers, and representatives for taxpayers, who are involved in an IRS audit genuinely want to cooperate with the assigned revenue agent conducting the civil tax investigation. But how should you approach the situation if the IRS asks the taxpayer to extend the normal assessment period by signing an agreement (Form 872)? Let’s start with an overview:
What is the statute of limitations on tax assessment?
Section 6501(a) of Title 26 establishes a generally applicable statute of limitations providing that the IRS may assess tax deficiencies within a 3-year period from the date a tax return is filed. In other words, the law grants the IRS a limited window of time to investigate and assess additional tax beyond the amount reported by a taxpayer on his/her own tax return. The statute of limitations “is intended to run against those who are neglectful of their rights, and who fail to use reasonable and proper diligence in the enforcement thereof . . . .” Pashley v. Pacific Elec. Co., 153 P.2d 325, 326 (1944) (internal citation omitted).
Why is the IRS asking the taxpayer for a statute extension?
On the one hand, the IRS may have encountered a particularly complex issues that requires more time to adequately understand the proper tax result. On the other, the IRS may not have been entirely diligent in properly and timely developing the audit. In either case, the IRS has determined it needs additional time to conduct the audit.
What administrative rules/policies apply to the IRS when it seeks a statute extension in a case?
The Internal Revenue Manual provides that it is the policy of the IRS to secure consents to extend the period to assess only in cases involving “unusual circumstances.” IRM 25.6.22.2.1(1). Two reasons most often cited by IRS agents to explain the need for a statute extension are: (1) the limitation period for a taxable year under exam will expire within 180 days and there is insufficient time to complete the examination and the administrative processing of the case; or (2) the assessment period must be extended so that the case can go to Appeals–there must be at least 395 days remaining on the assessment statute of limitations when the case is receive by Technical Services and at least 365 days remaining on the statute of limitations when the case is received by Appeals. IRM 25.6.22.2.1(3)a, b.
What should the taxpayer (and taxpayer’s representative) consider in deciding whether to agree to sign a statute extension?
First, the most pressing concern for a taxpayer when considering whether to sign a statute extension is likely this – will rejecting an IRS request to sign a statute extension create a greater problem for me? The calculation for a taxpayer is to determine which choice presents the worst case scenario: (1) signing a statute extension prolongs the audit and associated time/expense/stress; or (2) rejecting the IRS’s request presents the risk that the IRS will summarily determine tax adjustments for the tax year under audit or perhaps lead to other unknown problems from an irked revenue agent. Second, does rejecting the IRS’s request to sign a statute extension mean that the taxpayer is not cooperating in audit? Why does a taxpayer’s cooperation in an audit matter? Well, Congress offered a carrot for taxpayers to work cooperatively with the IRS in an audit. Under section 7491(a)(2)(B), if a taxpayer cooperates with the IRS during an audit, then the normal burden of proof flips from the taxpayer to the government. This is a meaningful procedural advantage for a taxpayer that should be considered in a taxpayer’s decision-making process. The bottom-line is that a taxpayer who refuses to sign a statute extension request is not considered to have failed to cooperate for purposes of section 7491(a)(2)(B). On this issue, tax representatives must consider whether advising their client not to sign a statute extension runs afoul of Circular 230. Generally, section 10.23 of Circular 230 provides that a practitioner “may not unreasonably delay the prompt disposition of any matter before the Internal Revenue Service.” Advising a client not to sign a statute extension requested by the IRS does not violate Circular 230.
How should the taxpayer (and taxpayer’s representative) respond to the IRS’s request for a statute extension?
Consider two suggestions: first, ask the IRS revenue agent to explain why additional time is needed in the audit. The IRS Internal Revenue Manual provides that if a taxpayer and/or authorized representative responds to a request to extend the assessment statute with questions or other concerns, “examiners will discuss the taxpayer’s rights . . . the reason for the request, and any other pertinent information, such as how the proposed extension date was determined and the fact the statute can, if necessary . . . to help the taxpayer make an informed decision.” IRM 25.6.22.3(7). Second, consult a tax attorney to consider the strategic benefits and hazards from rejecting the IRS’s request for the taxpayer to sign a statute extension request. In our view, there must be an exceptional circumstance for a taxpayer to sign a statute extension; otherwise, if the IRS failed to use reasonable and proper diligence in the enforcement of the assessment period, then that is not a problem that the taxpayer should have to address.