17.3 Statute of limitations and tax penalties

The IRS has strict rules about when it can assess taxes and collect payments. These time limits, called statutes of limitations, protect taxpayers from indefinite IRS action. Understanding these deadlines is crucial for managing tax obligations and avoiding costly penalties.

Penalties are the IRS's way of enforcing compliance with tax laws. From late filing fees to fraud charges, these penalties can add up quickly. Knowing how to avoid them—and how to request abatement if they're imposed—is essential for minimizing tax liabilities and maintaining good standing with the IRS.

Statute of Limitations for Tax Claims

Assessment and Collection Timeframes

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• Statute of limitations sets legal time limits for IRS actions and taxpayer claims
• General assessment period spans 3 years from return filing date or due date (whichever is later)
• Extended 6-year assessment period applies for substantial income understatements (25%+ of gross income)
• No time limit exists for assessment in fraud cases or when no return filed
• IRS collection period typically lasts 10 years from tax assessment date
• Taxpayers must file refund claims within 3 years of return filing or 2 years of tax payment (whichever is later)

Extensions and Exceptions

• Form 872 (Consent to Extend the Time to Assess Tax) allows voluntary extension of assessment period
• Statute of limitations suspended during bankruptcy proceedings
• Combat zone service for military personnel pauses time limits
• Taxpayer absence from U.S. for extended period may toll statute
• Certain IRS challenges (summons enforcement) can extend deadlines

IRS Penalties for Noncompliance

Filing and Payment Penalties

• Failure-to-file penalty accrues at 5% of unpaid taxes per month (maximum 25%)
• Failure-to-pay penalty accumulates at 0.5% of unpaid taxes per month (maximum 25%)
• Combined monthly rate for both penalties capped at 5%
• Estimated tax penalties apply for insufficient payments throughout year (calculated using Form 2210)
• Trust Fund Recovery Penalty holds responsible persons liable for unpaid employment taxes (100% of trust fund portion)

Accuracy and Fraud Penalties

• Accuracy-related penalties amount to 20% of underpayment
  • Imposed for negligence, substantial understatement, or valuation misstatement
  • Substantial understatement defined as exceeding greater of 10% of tax or $5,000 ($10,000 for corporations)
• Fraud penalty equals 75% of underpayment attributable to fraud
  • Requires clear and convincing evidence of fraudulent intent
  • No statute of limitations for assessment in fraud cases

Information Reporting Penalties

• Failure to file information returns (Forms 1099, W-2) incurs penalties
  • $50 per form if corrected within 30 days
  • $110 per form if corrected after 30 days but before August 1
  • $280 per form if not corrected or filed after August 1
• Intentional disregard increases penalty to $570 per form or 10% of amount reported
• Foreign Bank and Financial Accounts (FBAR) penalties for unreported offshore accounts

Penalty Abatement Criteria and Process

Reasonable Cause and First-Time Abatement

• Reasonable cause abatement requires demonstrating failure was not due to willful neglect
  • Common reasons include death, serious illness, natural disasters (hurricanes)
  • Ignorance of law generally not accepted as reasonable cause
• First-time penalty abatement available for certain penalties if clean compliance history
  • Eligibility requires no penalties in prior 3 years and all required returns filed
  • Applies to failure-to-file, failure-to-pay, and failure-to-deposit penalties

Statutory Exceptions and Administrative Relief

• Statutory exceptions provide penalty relief in specific situations
  • Military service in combat zones
  • Presidentially declared disaster areas
• IRS may offer administrative waivers for widespread issues
  • Example: Systemic errors affecting many taxpayers
• Offer in Compromise allows settlement of tax debt, including penalties, for less than full amount
  • Based on doubt as to collectibility, doubt as to liability, or effective tax administration

Abatement Request and Appeals Process

• Submit written penalty abatement request explaining circumstances
  • Include relevant documentation supporting claim (medical records, disaster declarations)
• IRS reviews request and issues determination letter
• Appeal rights available if abatement denied
  • File protest with IRS Office of Appeals within 30 days of determination
  • Appeals officer conducts independent review of case
• Taxpayer Advocate Service can assist with hardship cases or systemic issues

Interest Charges on Tax Underpayments and Overpayments

Underpayment Interest Calculation

• Interest accrues on unpaid taxes from return due date until payment
• Compound interest calculated daily (interest charged on tax and accumulated interest)
• Current underpayment rate: federal short-term rate + 3% (adjusted quarterly)
• Underpayment interest begins on original due date, regardless of extensions
• Large corporate underpayments (exceeding $100,000) subject to higher rate (federal short-term rate + 5%)

Overpayment Interest and Special Rules

• IRS pays interest on tax overpayments
  • Interest starts from later of return due date or date of overpayment
• Overpayment interest rate: federal short-term rate + 2% for individuals
• Corporate overpayment rates vary based on amount
  • Federal short-term rate + 0.5% for portion exceeding $10,000
  • Federal short-term rate + 1.5% for portion up to $10,000
• Interest netting rules apply when taxpayer has both underpayments and overpayments

Interest Abatement and Suspension

• Interest rarely abated except for IRS errors or unreasonable delays
  • Example: IRS loses tax return and takes excessive time to process
• Interest suspended in certain cases
  • IRS fails to provide notice of deficiency within 36 months
  • Taxpayer enters into installment agreement (interest continues but penalties may be abated)
• Disaster relief may include interest suspension for affected taxpayers