March 30, 2020
IRS Audit Statute of Limitations May Be Extended Pursuant to Internal Revenue Code § 6501(c)(8) for Failure to Report Foreign Financial Activity
Generally speaking, Section 6501 of the Internal Revenue Code (IRC) provides that the statute of limitations within which the IRS may make an assessment of additional taxes and/or penalties against a taxpayer is three years from the date that the return is filed. For example, if a taxpayer files a 2019 income tax return on April 15, 2020, without extending the “due date” of the return, then the general rule states that the IRS has until April 15, 2023, to assess any additional taxes or penalties for tax year 2019. However, section 6501 also provides some exceptions to this general rule. For example, there is no statute of limitations on assessing additional taxes or penalties if a taxpayer fails to file an income tax return altogether.
There are additional exceptions to the general “three year” rule as well. Some of these additional exceptions give the IRS a specific amount of additional time to assess additional taxes and penalties, while other additional exceptions give the IRS an unlimited amount of time to assess additional taxes and penalties.
One of these additional exceptions is found in section 6501(c)(8) of the IRC. Section 6015(c)(8) focuses on the failure of a U.S. taxpayer to file certain information returns relating to various foreign entities (such as foreign corporations, foreign partnerships, and foreign trusts) with which that taxpayer has a relationship. Section 6501(c)(8) provides that, where a U.S. taxpayer fails to timely file a required information return relating to a foreign entity with which the taxpayer has a relationship, the IRS has an increased period of time within which to assess additional taxes and penalties.
How much additional time (in addition to the “normal” three year time period) does the IRS have to assess additional taxes and penalties if a U.S. taxpayer fails to file a required foreign entity information return for a particular year? The answer is “it depends.” If the taxpayer never files the required foreign entity information return, even though they file the underlying income tax return, there are two possibilities. First, the IRS may have “forever” to assess a limited amount of additional taxes and penalties, i.e., the IRS may have “forever” to only assess additional taxes and penalties that relate to the foreign entity for which the foreign entity information return was not filed (if other exception to the “normal” three year period applies). Under this scenario, the IRS does not have “forever” to audit the entire return in order to assess additional taxes and penalties. Rather, once the “normal” three year statute of limitations has expired, the IRS can only assess additional taxes and penalties that relate to the unfiled foreign information return. But there is no time limit on the ability of the IRS to do this type of “limited scope” audit as long as a foreign entity information return remains unfiled.
The second possibility is much more troubling for taxpayers. The IRS may in fact have “forever” to audit the entire return to assess additional taxes and penalties, even taxes that are unrelated to the unfiled foreign entity information return, just because the taxpayer failed to file a required foreign entity information return. This is in fact the rule unless the taxpayer can prove that the taxpayer’s failure to file the applicable foreign entity information return(s) was due to “reasonable cause.” If the taxpayer cannot prove the existence of “reasonable cause” for their failure to file the relevant foreign entity information return(s) and those foreign entity information returns remain unfiled, the IRS will have forever to audit the entire tax return and assess additional taxes and penalties. (This second possibility normally does not apply to tax years prior to 2006. If the IRS is auditing very old tax years, a special determination needs to be made whether this second possibility applies.)
The failure to file any foreign entity information return triggers the application of this rule. Thus, even where a taxpayer files an income tax return on time, if the taxpayer does not file all required foreign entity information returns, the IRS may have forever to audit the entire tax return and assess additional taxes.
Once the taxpayer files all required foreign entity information returns that are accurate and complete, however, under section 6501(c)(8) the IRS will have three years from the date on which all of the required foreign entity information returns are filed with the IRS to assess additional taxes and penalties (if one of the other exceptions to the “normal” 3 year period does not apply).
What foreign entity information returns need to be filed with the IRS? These Forms include the following:
Form 5471 – You may need to file this Form if you are a shareholder, officer and/or direct of a foreign corporation or if you control a foreign corporation.
Form 3520 – You may need to file this Form if you receive a gift from a foreign person, estate or entity or if you have a relationship with a foreign trust.
Form 3520A –This Form is filed by a foreign trust that has at least one U.S. owner. Although the Form is filed by the Trustee of the foreign Trust, it is the U.S. owner(s) who is/are penalized if the Form is not timely filed.
Form 5472 – You may need to file this Form if you are a U.S. corporation with a foreign shareholder or if you are a foreign corporation doing business in the United States.
Form 8938 – You may need to file this Form if you own assets that are located outside of the United States that exceed a specified threshold value.
Form 8865 – You may need to file this Form if you have or had an interest in a foreign partnership.
Form 8858 – You may need to file this Form if you own a foreign disregarded entity (FDE) or foreign branch (FB) directly or you have a connection with and FDE or FB through another entity with which you have a connection.
Form 926 –You may need to file this Form if you transfer property to a foreign corporation.
Form 8621 – You may need to file this Form if you have an ownership interest in a foreign corporation that is treated as a Qualifying Insurance Corporation or if you are a direct or indirect a shareholder of a passive foreign investment company (PFIC).
The dangers posed by the rules in section 6501(c)(8) are self-evident. These rules make it critically important for taxpayers to understand when they are required to file foreign entity information returns. A failure to file all required foreign entity information returns could result in the IRS having an unlimited amount of time within which to audit your tax returns and could expose you to substantial penalties for the failure to timely file those information returns.
If you determine that you failed to file a required foreign entity information return in one or more prior tax years, it is critically important that you understand all of the available options for dealing with that situation, including the possible assertion of civil penalties by the IRS.
If the IRS believes that you intentionally failed to file one or more foreign entity information returns, it is also critically important that you understand your potential exposure for criminal investigation and prosecution. The IRS has placed a high priority on the enforcement of the rules governing foreign entity information returns.
If you have any questions regarding these matters, please contact our office.
- April 3, 2020 BBA Centralized Partnership Audit Rules and Bankruptcy
- March 30, 2020 IRS Audit Statute of Limitations May Be Extended for Failure to Report Foreign Financial Activity
- March 10, 2020 The Impact of the Last Known Address Rule on United States Taxpayers
- March 5, 2020 7th Annual Young Tax Lawyers Conference
- February 20, 2020 The United States Tax Court Paves Way for Taxpayers to Escape Civil Penalties on Federal Income Tax Assessments