As the Service becomes more and more backlogged in the processing of cases, it is increasingly resorting to requests for extensions of the limitation period on assessment. There are a number of factors to consider when advising a client whether to agree to such a request.
Section 650 1(a) sets forth the general rule that an assessment of tax must be made within three years from the date the tax return was filed. There are however, exceptions to this rule. Section 650 1(e) provides for a six-year statute of limitations in the case of “substantial omission of items.” (“Substantial” is an amount in excess of 25% of gross income.) Further exceptions are set forth in Section 6501. In the case of a false return (Section 6501(c)(1)), the willful attempt to evade tax (Section 6501(c)(2)), and failure to file a return (Section 6501 (c)(3)), there is no statute of limitations on assessment or collection. The remaining subsections of Section 6501 relate to the limitation periods relative to holding companies and foreign tax credits and will not be discussed.
Section 6519(c)(4) provides the statutory basis for agreements between taxpayers and the Service to extend the general statue of limitations on assessment. This section states that where, before the expiration of the statute of limitations, both the Service and the taxpayer have agreed in writing to its extension, the tax may be assessed at any time prior to the expiration of the agreed-upon period. The agreed-upon period may be further extended by subsequent agreements in writing made before it expires. In addition, Section 6229 (b)(I) (B) provides that the tax-matters partner, or any other person authorized by the partnership, may enter into the agreement to extend the statute with respect to a partnership item. Forms 872-0 and 872-P are used for items of a partnership.
Generally, it is the Service who requests that the statutory period be extended for purposes of being-fling or completing an audit or to all consideration of a protest filed by the taxpayer. Occasionally, the taxpayer will request an extension for purposes of substantiating items under review or perhaps in order to keep the statute open for purposes of filing a claim for refund.
There are nine IRS forms that allow the statute to be extended. However, only those forms applicable to individual taxpayers will be discussed.
General consent. The general consent, Form 872. Consent to Extend the Time to Assess Tax, “extends limitation to the earlier of a specified date or the assessment date of an increase in tax reflecting the final Service determination of tax.” In simple terms, this means that the consent is only for a state period; however, such consent will terminate if the Service makes an assessment prior to the specified date of termination.
Special consent. The special consent, Form 872-A, Special Consent to Extend the Time to Assess Tax, extends the limitations period until 90 days after: (1) mailing by the IRS of notification of termination of consideration; (2) election by the taxpayer to terminate the agreement; (3) the mailing of a notice of deficiency. In the last case, the period for assessment for the year or years involved will not expire until 60 days after period during which the assessment is prohibited. Although Form 872-A purports to extend the limitations period indefinitely, the Ninth Circuit in McManus, in affirming the Tax Court, held that the statutory waiver does not extend the statute of limitations forever, but rather it is operative for a “reasonable time” only.
There has been a substantial policy shift in the IRS ranks with respect to the use of consents. Revenue Procedure 57-6, setting forth the Service’s then-current position, stated in relevant part as follows: “It has been the long-established policy of the Service to secure a consent, extending the statutory period of limitation, only in a case involving unusual circumstances. An examining officer must have the approval of his group supervisor prior to requesting a consent. Approval will not be granted in any case where previous contact with the taxpayer has not been made, except where compelling reasons exist.
“It is the policy and purpose of the Service to keep to an absolute minimum the number of consents obtained from taxpayers.”
Time has changed. Currently, the Service uniformly requests taxpayers to extend the statute not only prior to the completion of an audit but sometimes, when an audit has not yet begun.
Revenue Procedure 79-22 sets forth the conditions under which the Form 872-A will be accepted.
The Service’s articulated reason for use of the special consent is that it is often difficult to forecast the time required for adequate consideration of a case, particularly where complex or intricate questions of fact or doubtful issues of law are present. As a result, the period of limitation may be extended by use of Form 872 beyond the time required for Service consideration, or it may be necessary to request a renewal consent if inadequate time was provided by the first consent.
The Revenue Procedure further states that the special consent is provided to relieve taxpayers and the Service from the inconvenience of obtaining renewal consents, to relieve the Service, in part, of the problems of maintaining controls to ensure that the period of limitation does not expire during consideration of a case, and to provide a means of restricting the period of limitation to the minimum time required for Service consideration.
Further, the Service is not required to notify the taxpayer of its approval of the acceptance of the waiver of the statute of limitations to make the waiver effective.
Restricted consents. Taxpayers and the Service may agree to restrict the consent to specific items on the return. The language of restriction will be set forth in the consent. As a general rule, the Service neither requests nor accepts a restricted consent if there are more than two issues that are to be held open.
Further, the Service does not ordinarily accept a restricted consent until all of the following conditions are met:
1. The examination has been completed.
2. The examination report has been prepared.
3. Use of restricted consent at the district level is approved by the appropriate Service representative.
4. Any issues not covered by the restricted consent are agreed upon and appropriate action has been taken regarding those issues.
Revenue Procedure 68-31 contains the procedures under which the scope of a Form 872 may be restricted to one or more issues. According to the Revenue Procedure, restricted consents “will be entered into only under circumstances referred to in section 2.01 or where other equally meritorious circumstances exist.” Further, a partial agreement on other items, if any, must be executed.
Termination of the special consent: The special consent (Form 872-A) may be terminated by the taxpayer by a notification in writing to the Service. Such notification must be made by use of Form 872-1, Notice of Termination of Special Consent to Extend the Time to Assess Tax. Termination is effective upon receipt by the Service. Thereafter, the Service has 90 days in which to issue a statutory notice of deficiency to the taxpayer.
The burning question is, therefore, when should a taxpayer execute a consent to extend the statue of limitations? Unfortunately, there is no hard and fast rule. Factors to consider are the number and type of issues subject to IRS scrutiny, whether the taxpayer has substantiation and legal authority for the positions taken in the return, the accrual of interest, and the potential for filing a claim for refund.
If the taxpayer declines to execute the extension, then the Service will issue a statutory notice of deficiency. At this juncture, the taxpayer may either (1) file a petition with the Tax Court within 90 days of issuance of the deficiency notice; (2) pay the assessed tax deficiency, claim a refund, and file suit in either an appropriate district court of the Claims Court.
On the other hand, a taxpayer that executes a special consent is effectively giving the Service an unlimited amount of time to review each and every item on the return. Also, taxpayers must remember that extension of the statute of limitations does not suspend the accrual of interest. Therefore, if it is ultimately determined, either through settlement or court decision, that the taxpayer is liable for additional tax, then that much more interest on the deficiency will have accrued during the period in which the extension was granted.
Many taxpayers are intimidated executing an extension of the statute because they are told by the Service, that unless the extension is obtained, a notice of deficiency will be issued. A large percentage of taxpayers and their representatives are of the opinion that the issuance of a notice of deficiency is the worst possible result, and thus, they will grant the Service its extension.
What is the practical result of extending the assessment period? Rather than work on the taxpayer’s case, the Service will proceed to devote its time to priority case, i.e., cases in which extensions have not been obtained. While for a length of time, no news seems to be good news for the taxpayer in that he need take no formal action, months or perhaps years later, a notice of deficiency will be issued. Usually, and particularly in the case of a return involving a tax shelter item, the deficiency notice is issued without further examination or appeal consideration.
The economic result is that additional interest on the settled-upon deficiency, if any, will have accrued while the year(s) were under extension. Although the current rate of interest of underpayments is 9%, rates have greatly fluctuated in the 19Sos, reaching a high of 20% in 1982. Further, TEFRA added Section 6621, which imposes a 120% interest rate on “tax motivated transactions,” a category under which many items will fall. Section 6404(e), added by the Tax Reform Act of 1986, provides for the abatement of interest when a Service representative either fails to perform in a timely fashion or errs in the performance of a ministerial act. The abatement of interest in this case is not mandatory and will be determined on a case-by-case basis. However, if a taxpayer executes a consent and the case is not worked by the Service, the taxpayer may argue under Section 6404(e) for an abatement of interest when a deficiency is determined to exist.
Is there any real benefit to the taxpayer by granting the extension? Section 651 1(c)(I) provides that upon an expiration of an extension of the statute of limitations, the taxpayer has an additional six months to claim a refund for that extended tax year. Thus, if a Form 872-A is executed, conceivably the refund period does not expire until six months after that mode of extension is terminated. In that six-month period the taxpayer could file a refund claim or file a Tax Court petition if a notice of deficiency is issued, asserting the right to overpayment pursuant to Section 65 12(b).
Another common situation to consider is the one where the Service is asserting the civil fraud (Section 6653 (b)) penalty for a tax year, the normal three-year period of assessment limitations is about to expire, but the Service is unsure fraud exists and whether it can carry its burden of proof. In this situation, the Service may request an extension of the assessment limitation period. In this instance, unless exceptional circumstances exist, extension should be declined. If the Service asserts the civil fraud penalty, the statute of limitations on assessment pursuant to Sections 6501 (c)(1) and (2) never expires.
Therefore, if no extension is granted, the Service can assert other penalties, notably the negligence penalty (Section 6653(a)), together with accrued interest compounded daily. If the issues are simple and merely involve substantiation, then a limited consent is viable alternative to an immediate statutory notice, assuming that the criminal investigation has terminated, and the Service has agreed not to assert the civil fraud penalty. As in all cases of granting an extension, execution of the extension to extend the period for assessment will also extend the statute for purposes of filing a refund claim, according to Section 6511(c)(1).
Furthermore, executing a consent may be considered if the item in question relates to taxpayer’s interest in a partnership that is currently under audit or involved in settlement negotiations with the Service. The extension allows the taxpayer to sit on the sidelines while the battle is being fought. While this “wait and see” attitude allows the taxpayer to take no further action currently, the plan could backfire. The author is aware of one circumstance where a taxpayer executed a succession of consents on Forms 872 and ultimately executed a Form 872-A consent.
Subsequently, the Service proposed a pattern of settlement of the partnership item at issue in the taxpayer’s return. However, the Service did not advise the taxpayer of the settlement although his name was included in the list of investors attached to the settlement proposal. Upon advice if counsel, the taxpayer finally terminated the consent, was issued a notice of deficiency and filed a petition with the Tax Court.
It was not until the appellate conference, that the taxpayer, through counsel, was advised that a pattern settlement had been reached seven years prior to issuance of the notice of deficiency. Given the circumstances, the taxpayer who extended the assessment period by using Form 872-A might never have been advised of the settlement. The settlement occurred in a different region of the country from the taxpayer’s residence.
Another consideration is that without the issuance of either a “30-day” or “90-day” letter by the Service, the taxpayer’s only recourse, if he or she decides to pay the full tax asserted to stop the running of interest, is to file an amended return. This act precludes the taxpayer from subsequently obtaining Tax Court jurisdiction (assuming no other adjustments), if by amendment no notice of deficiency thereafter is issued by the Service. (The taxpayer could estimate the tax deficiency asserted by the Service, and pay a percentage of the prospective deficiency. By so doing, the taxpayer reserves the option to receive a notice of deficiency and file a petition in the Tax Court.)
On the other hand, if the taxpayer does not execute the consent and the notice of deficiency is issued, taxpayer may make a full payment of the tax and penalties and retain Tax Court jurisdiction. Payment is recommended to be made pursuant to Section 6213(b)(4), which provides for an immediate assessment of the amount paid. The effect of payment in this manner is to (1) halt the accrual of interest on the deficiency and (2) begin interest running in the taxpayer’s favor. This payment is different from payment in the form of a cash bond pursuant to Rev.Proc. 82-51. In the cash bond procedure, further accrual of interest ceases, but interest in favor of the taxpayer does not begin to run during the time the Service has the funds.
Finally, taxpayers should be aware of the current position of the Service’s Chief Counsel on this matter. Apparently, from recent litigation, it is the Service’s litigating position to assert the frivolous litigation penalty in appropriate cases where the taxpayer declines to execute a statue extension. Whether this will in fact continue to occur remains to be seen, but it is indeed a “chilling” possibility that needs to be considered, in light of the possible Government assertion that failure to extend the statute of limitations will be considered by the Service as part of a course of conduct by the taxpayer not to exhaust his, her or its administrative remedies.
However, the Tax Court, in Minahan, recently held that a taxpayer’s failure to extend the limitations period on assessment does not Constitute a failure to exhaust administrative remedies and therefore does not preclude an aware of litigation costs. In Minahan, the Service audited taxpayers who had executed similar stock purchase agreements with separate trusts and had subsequently sold unregistered common stock of publicly traded corporation to each trust at a value equal to the stock exchange value as of the date of the agreement. Although the Service determined deficiencies in the taxpayers’ Federal gift taxes, it later conceded all disputed issues.
The taxpayers subsequently filed motions for litigation costs pursuant to Section 7430 and Rule 231 of the Tax Court Rules of Practice and procedure. The court rejected the Government’s argument that taxpayers should not be awarded litigation costs on the basis that they had failed to exhaust administrative remedies. As the Minahan court stated, “…an extension of time for assessment is not an administrative remedy at all; consequently it exhaust.” The court further stated, “There is no statutory authority to impose a condition of extending the period of limitations on assessment in order to qualify for litigation costs.”
Should the Service nevertheless pursue the frivolous litigation penalty, it may be confronted with a double-edged sword. Perhaps the Service has not done all it could to “work the cases.” In short, taxpayers may want to argue that the Service has been arbitrary and capricious by (1) not working the case and (2) by asserting “box car” adjustments disregarding the facts, circumstances and sometimes the law.
To accomplish early disposition of the tax case at the administrative level requires a responsible and intelligent attitude by taxpayers and their representatives, as well as the Service and its representatives. An early disposition of all tax matters is in the best pecuniary interest of everyone.
While particular facts and circumstance may vary to alter the conclusion, generally taxpayers should not execute consents to extend the statute of limitations except in those cases in which there exists a definite discernable benefit to the taxpayer. Otherwise, taxpayers are inviting the Service to take their case and put it into the “IRS warehouse,” creating a situation analogous to the final scene in the movie, “Raiders of the Lost Ark,” where the “Ark” was wheeled into a cavernous warehouse, probably only to be found again, if ever, many years down the road and after considerable effort to locate the “file” and work the case.
Of course, the best solution to the extension of the statute of limitations problem is an early disposition of the tax controversy. This can occur, if both the taxpayer and the Service work together, and follow through in completing the case in a reasonable and prompt manner.
Delay benefits no one.*