A sign outside the Internal Revenue Service is seen August 8, 2015 in Washington, DC. AFP PHOTO / ... [+]
The statute of limitations is an important concept in law. Generally, it requires a litigant to file a claim within a specified period of time or forever lose that claim. The legislature usually imposes statute of limitations requirements based on fairness and finality goals, recognizing that memories tend to fade, and evidence may eventually be lost or destroyed. Therefore, all things being equal, litigants with claims should exercise due diligence in bringing these actions against other parties.
Federal tax law also has numerous statutes of limitations. Applicable to the IRS, section 6501 generally requires the IRS to make a tax assessment within three years from the return filing date or the return filing deadline, whichever occurs later. However, section 6501(c)(1) provides an exception to this rule where there has been a false or fraudulent tax return filing. In these instances, the statute of limitations period remains open indefinitely, often even if the taxpayer later attempts to cure the fraud through a corrected amended return.
Regrettably, Congress wrote section 6501(c)(1) in the passive voice. More specifically, that provision states: “In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed . . . at any time.” Section 6501(c)(1) does not identify who must conduct the false or fraudulent return filing with the intent to evade tax. As any grammarian would confirm, an author’s decision to use the passive voice often results in ambiguity, especially when the reader needs to identify the subject or actor in the sentence.
Although federal courts have had no trouble in concluding that a taxpayer’s own fraudulent conduct fits squarely within section 6501(c)(1), tricky issues have arisen regarding whether that provision also captures third parties who engaged in fraud, e.g., a tax preparer or a tax advisor. The example below illustrates this point.
Assume that Adam provides tax information annually to his tax preparer, Olivia. Olivia reviews the information and reports in one tax year that Adam is entitled to a large charitable contribution deduction. Adam never mentioned any charitable contributions during the year; moreover, Adam never provided any substantiation to Olivia to suggest that he had charitable contributions. The IRS can prove that Olivia acted with fraudulent intent in claiming the charitable contribution deductions on Adam’s behalf. Conversely, the evidence shows that Adam was unaware of the claimed deduction and otherwise acted in good faith in relying on Olivia to prepare his tax return. On these facts, may the IRS assert that section 6501(c)(1) applies to keep the statute of limitations period open indefinitely with respect to Adam’s tax return?
The answer may surprise you. In 2007, the Tax Court squarely addressed this issue in Allen v. Comm’r, 128 T.C. 37 (2007), concluding that the statute of limitations period remained open indefinitely where a tax preparer engaged in fraud, even where the taxpayer did not. And more recently, in Murrin v. Comm’r, T.C. Memo. 2024-10, the Tax Court reaffirmed its decision in Allen.
In Murrin, the taxpayers used a tax preparer to prepare and file their tax returns for 1993 through 1999. Unbeknownst to the Murrins, the tax preparer reported fraudulent items on the tax returns. The IRS later discovered the fraud and, in 2019, issued a notice of deficiency. Because roughly twenty years had passed since the filing of these returns, the Murrins argued in Tax Court that the IRS was barred from making assessments under the general three-year statute of limitations period. The Tax Court disagreed, concluding that it would continue to follow its decision in Allen.
Significantly, there is authority outside the Tax Court to support a contrary view. In BASR P’ship v. United States, 795 F.3d 1338 (Fed. Cir. 2015), the U.S. Court of Appeals for the Federal Circuit held that the IRS may not use section 6501(c)(1) to extend the statute of limitations where an attorney fraudulently advised a partnership to enter into a “tax-advantaged investment opportunity” to offset significant capital gains. Notably, though, a strong dissent indicated that it would have followed the same reasoning as set forth in Allen.
Given the conflicting decisions in Allen and Murrin, on the one hand, and BASR P’ship, on the other hand, there can certainly be considerable debate on which side is correct. No doubt, taxpayers have a duty to review their tax returns prior to filing, regardless of whether they use a tax preparer. However, most taxpayers lack a good understanding of tax return reporting, particularly those unsophisticated in business and tax return matters. And although the government may be at a disadvantage in identifying the fraudulent reporting through no fault of its own, this argument fails to consider the harshness that occurs to the otherwise honest taxpayer. Indeed, in Murrin, the taxpayers now find themselves not only liable for the deficiencies from more than twenty years ago but also the accompanying interest that would have compounded daily on those deficiencies. Because of the lengthy timeframe, it is likely that the interest amounts at issue in that case now far exceed the amounts of the deficiencies that the IRS seeks to collect.
This issue is also more prevalent than you would think. Indeed, look at this issue in the context of a fraudulent ERC filing. The IRS has previously communicated that it is aware of third-party promoters who fraudulently filed ERC claims on behalf of honest businesses. As a general matter, the IRS would have three years from the deemed employment tax return filing date to make an assessment of additional employment taxes. Under the decisions in Allen and Murrin, however, that period of time would conceivably extend indefinitely to the extent the IRS can demonstrate a false or fraudulent ERC filing made by a third-party promoter.
In addition, the same rationale in Allen and Murrin could also apply to another statute of limitations provision—section 6532(b)—that extends the period for the government to file an erroneous refund lawsuit to five years (from two years) “if it appears that any part of the refund was induced by fraud or misrepresentation of material fact.” Similar to section 6501(c)(1), section 6532(b) also speaks in the passive voice. Taxpayers can therefore expect the IRS to make the same arguments that were made in Allen and Murrin to extend the period of limitations applicable under section 6532(b).
Perhaps the only silver lining here for taxpayers is that BASR P’ship remains good law and that other federal courts outside the Tax Court have not yet had an opportunity to decide the section 6501(c)(1) issue. To the extent taxpayers can litigate these claims in the U.S. Court of Federal Claims, it is likely advisable for them to do so, although this option will not be available in every situation. Taxpayers forced to litigate this issue in the Tax Court should recognize the likely outcome in the light of Allen and Murrin—however, these taxpayers may be able to take some solace in knowing that most appellate courts have not made an ultimate determination on this issue.
