Stop the Clock: Your most important defense against an audit

In a recent tax court decision, a judge ruled that a joint tax return not signed by both spouses is not a validly filed tax return.* This seems like a simple ruling about the signature line on a 1040 tax form. The true reason for the ruling; to keep the statute of limitations open to give the IRS the authority to audit this couple’s prior year tax returns. The lesson here is not only found on the signature line of the tax return, but on closing out past tax returns from the possibility of audit.

The rules

Three (3) year rule. The IRS can audit a tax return for up to three years after the tax return is filed or the original filing due date, whichever is later.

Six (6) year rule. The three year audit window doubles if you understate your taxable income by 25% or more. This includes understating the taxable value of property transferred to you.

The forever rule. There is no time limit if you fail to file a tax return, there is fraudulent activity, or if certain unreported foreign assets are involved.

State rules vary. Each state has its own statute of limitations. Many states add six months to one year to the federal window to allow the state time to react to any federal tax changes due to an audit or amended tax return.

Amended returns. If you amend your federal tax return, the IRS generally has sixty days to review the revision. This may add time to the audit window, but only if the amended tax return is filed near the end of the audit window.

Some tips

Keep the time as short as possible. Try to file your tax return on or before the initial filing deadline. For most of us, this is April 15th. Keep records that document the timing of your filing either by using certified mail or keeping copies of e-file confirmations.

Start the clock. Remember, until you file your tax return the audit clock never starts. This is the problem our couple had with their unsigned tax return from the early 2000’s. Without both signatures, the jointly filed tax return was not deemed to have been filed. So the audit time-frame did not start. This left the taxpayers with a very large (and expensive) available audit window.

Understand the permission to extend. On occasion, the IRS may ask you for permission to extend the audit period. They will do this to buy time to finish an audit. If you refuse, the audit window is closed, but the IRS may present you with a tax bill based upon incomplete information. Should this request be delivered to you, ask for assistance before agreeing to an extension.

Know your state’s rules. States have different statute of limitation rules. For instance, some states hold their audit periods open indefinitely if you file an amended federal tax return, but fail to file an amended state tax return.

While many look at the April 15th filing deadline with dread, remember each deadline also closes the ability to audit a timely filed prior year tax return.

* Reifler v. Commissioner, T.C. Memo. 2015-199