Taxes are generally required to be assessed by the I.R.S. within three years after a taxpayer’s return is filed. Code §6501(a). In the case of a false or fraudulent return filed with the intent to evade tax, or if the taxpayer fails to file a required return, the tax may be assessed at any time. Code §6501(c)(1), (2), and (3).
Code §6501(c)(8) provides an exception to the three-year period of limitations due to failures to provide information about cross-border transactions or foreign assets. Under this exception, the limitation period for assessment of tax does not expire until three years after the required information is provided to the I.R.S. The disclosure forms relevant to Code §6501(c)(8) include:
- Form 8621
- Code §1298(f), regarding certain passive foreign investment companies (“PFICs”)
- Form 5471
- Code §§6038 and 6046, regarding certain foreign corporations
- Form 8865
- Code §§6038 and 6046A, regarding certain foreign partnerships
- Form 8858
- Code §6038, regarding certain foreign disregarded entities
- Form 5472
- Code §6038A, regarding certain 25% foreign-owned U.S. corporations and certain foreign corporations engaged in a U.S. trade or business
- Form 926
- Code §6038B, regarding certain transfers of property to foreign corporations
- Form 8938
- Code §6038D, regarding certain foreign financial assets held by individuals
- Form 3520-A
- Code §6048, regarding certain foreign trusts with U.S. owners
If the taxpayer does not have reasonable cause for the failure to provide the information required by these forms, the suspension of the limitations period applies to all issues with respect to the income tax return. If the taxpayer can establish reasonable cause, the limitations period is suspended only for the item or items related to the failure to disclose.
Not only can the failure to file the necessary forms result in an exception to the three-year period of limitations, but omission of income from the tax return can extend the statute of limitations to six years after the tax return was filed. For example, if more than 25% of a taxpayer’s gross income is omitted from the tax return, the statute of limitations is extended to six years. Code §6501(e)(1)(A)(i). The courts have held that if the taxpayer omits the requisite amount of gross income from his return, the taxpayer’s entire tax liability for the particular taxable year is subject to the six year limitations period. Colestock v. Commr., 102 T.C. 380 (1994).
The statute of limitations is also extended to six years if an individual omits from income an amount attributable to foreign financial assets that must be reported on Form 8938. Code §6501(e)(1)(A)(ii).
A less well known rule that also extends the statute of limitations to six years is when a taxpayer owns at least 10% of the voting shares of a controlled foreign corporation (“CFC”) and the taxpayer omits from his gross income certain deemed inclusions known as “Subpart F Income” or certain “investments in U.S. property.” Code §6501(e)(1)(C). Subpart F Income is generally income earned by a CFC that is deemed distributed to its 10% U.S. owners. Code §951(a), et. seq. An investment in U.S. property generally occurs when a CFC invests in certain U.S. assets or makes loans to certain U.S. persons. Code §956.
Applying the same logic as the Tax Court did in Colestock, supra, it appears that the omission of Subpart F Income or the omission of an investment in U.S. property would cause the statute of limitations to be open for all issues with respect to the income tax return, and not only with respect to the item of income that was omitted.
There is no minimum amount of a deemed inclusion that must be omitted to extend the statute of limitation to six years. Even if one dollar of Subpart F Income were omitted from a tax return, it appears that the statute of limitations to assess tax for the entire tax return would remain open for six years.
It is possible that this rule could be used by the I.R.S. as a sword against large multinational corporations (“MNCs”) that have many CFCs. For example, say a large MNC with 500 CFCs files its 2009 tax return on March 15, 2010, reporting what it believed to be the proper amount of Subpart F Income on the tax return. The three year statute of limitations on assessment would generally expire on March 15, 2013. If, in 2014, an I.R.S. revenue agent discovers an adjustment that he or she would like to make to the MNC’s 2009 tax return, but the adjustment is not attributable to one of the items that would extend the statute of limitations to six years, the revenue agent may search for any missing Subpart F income for 2009. Even if a small amount of unreported Subpart F income could be found, it appears that the statute of limitations for all items on the tax return would be extended to six years.
The extension of the statute of limitations to six years would even appear to apply in cases where the MNC voluntarily admits to the I.R.S. that it had unreported Subpart F Income.