Utah Bar Journal

Little wonder that Justice Learned Hand once wrote:

In my own case the words of ... the Income Tax [code]... merely dance before my eyes in a meaningless procession: cross-reference to cross-reference, exception upon exception Ð couched in abstract terms that offer no handle to seize hold of Ð leave in my mind only a confused sense of some vitally important, but successfully concealed, purport, which it is my duty to extract.... (Learned Hand, the Spirit of Liberty (1952), p. 213.)

The good news is that it is no crime to misunderstand the tax code. Sure, if a person fills out a tax return incorrectly it may be audited and result in a subsequent tax bill, together with interest and maybe even underpayment penalties. But to go to jail a person has to "cheat," which means that the IRS can prove that a person willfully broke the law. That is a lot different from getting confused or misunderstanding something.

Neither must a taxpayer look over her shoulder for very long. Typically, the IRS can only audit taxes for three years from the date of filing (IRC ¤6501(a)), but in instances where a taxpayer understates gross income by more than 25%, that statute of limitations stays open for an additional three years (IRC ¤6501(e)(1)(A)). One might wonder why this six-year rule only applies to omissions from gross income, but not to omissions from taxable income. For instance, why wouldn't it apply in an instance where a taxpayer overstated deductions rather than understating income? The answer revolves around the concept of why we have a statute of limitations. Life has to go on, so if the players are on notice as to what the issues are, they have to act within a reasonable time frame in order to preserve their rights. Deductions are presumed to be examined in any ordinary audit based on documentation preserved by the taxpayer, but omissions from gross income are much harder to detect in an audit. As a matter of policy, the statute of limitations bar is a little higher for taxpayers underreporting gross income. Of course, the six year rule for 25% percent omissions of income also presumes that the taxpayer hasn't committed tax fraud by filing a false return with the intent to evade tax, not filing a return, or making any other willful attempt to evade tax, in which case the statute of limitation never runs (IRC ¤6501(c)).

By some strange coincidence, not paying taxes illegally is governed by ¤6501(c), whereas not paying taxes legally, as a tax exempt organization, is governed by ¤501(c). In other words, not paying taxes under ¤6501(c) is bad, unlike not paying taxes under ¤501(c), which is good. If your client isn't paying taxes, pay attention to the six. As stated above, if a person or entity doesn't pay taxes under ¤6501(c), the statute of limitations doesn't ever run. Or, as one dissenting and disgruntled judge put it,

[The IRS] would leave the statute open for that portion of eternity concurrent with the taxpayerÕs life, whether he lives 3 score and 10 or as long as Methuselah. In most religions, one can repent and be saved, but in the peculiar tax theology of [the IRS], no act of contrition will suffice to prevent the statute from running in perpetuity (Klemp v. Commissioner, 77 T.C. 201 (T.C. 1981)).

It is important to distinguish in this context between the aforementioned statute of limitations for the assessment of civil consequences, as opposed to the criminal consequences, which still carry a six-year statute of limitations. If a taxpayer fails to file a return or files a false one, a criminal prosecution can only be brought within six years of the offense, but in year seven or beyond a civil tax assessment is still possible if the case for civil fraud can be proven. From a practical standpoint, however, making a case for tax fraud after more than six years has passed can be difficult for government authorities, unless the evidence was collected within the six year window.

What of the truly repentant tax evader? Fortunately, though the laws of justice permit a heavy hand, government policy permits a little mercy from time to time, particularly if a taxpayer confesses before getting caught. Under the IRS' "voluntary disclosure" policy, taxpayers who do the mea culpa before "the man" is on to them can usually avoid a criminal prosecution. That is not necessarily an easy out for a tax cheat. To be a true voluntary disclosure, the confession has to be timely and complete, and the taxpayer has to be willing to be fully cooperative in the subsequent assessment and payment of the taxes, penalties and interest. To be timely, the disclosure has to occur before a triggering event, such as the beginning of an audit, the beginning of a criminal investigation, or (controversially) even before the receipt by the IRS of an anonymous tip of which the taxpayer may not even be aware. Thus, the decision to make a voluntary disclosure, rather than simply filing amended tax returns, needs to be carefully considered based on the facts and circumstances at the time.

It should also be remembered that the statute of limitations for tax matters is tolled when a taxpayer is living outside the United States for a continuous period of six months or more at a time (IRC ¤6503(c)). What's more, if a taxpayer has bank accounts outside the United States, it is not just tax returns that come into play. Taxpayers with a financial interest in or signatory authority over foreign bank accounts with collective balances over $10,000 have an obligation to file a disclosure form with Department of the Treasury, under Title 31 of the United States Code. This used to be only a requirement under Title 31 (The Bank Secrecy Act), but in 2004 Congress added a civil penalty for failing to file the form under the Internal Revenue Code (Title 26). Although the penalty may be waived if the taxpayer can show "reasonable cause" for failing to file the form, the penalties under Title 31 and Title 26 can be steep. The statute of limitations for assessing penalties due to willful failure to file the form under Title 31 is six years.

In addition to the limitations imposed on the Internal Revenue Service in assessing taxes, the IRS is also subject to time limits in connection with collecting them. Once a tax is assessed against a taxpayer, the IRS can actively attempt to collect for a period of ten years. This ten year rule may seem easy on its face; however, the ten year clock doesn't even start until taxes are actually assessed. It would be too convenient to say that these taxes relate to 1996, so the drama is over by the end of 2006. A tax assessment can happen immediately after a return has been timely filed, but it can also happen later; after an audit, for example, or at any time within the statute of limitations periods for assessing taxes described above. The ten year collection period can also be tolled during a period when bankruptcy proceedings are under way, when an offer to compromise the liability for a lesser sum has been submitted and is under consideration by the IRS - forestalling collection action - or, once again, when the taxpayer is residing abroad.

It was Benjamin Franklin who proclaimed that in this world nothing can be said to be certain, except death and taxes. But as somebody once quipped, at least death doesn't get worse every time Congress meets. The good news: whether we get things wrong by accident or on purpose, there are mechanisms for setting things straight, even if it is just through the passage of time. Everyone understands that the tax code is complex, but despite its faults, the tax code seems to work for most people, most of the time (regardless of how they may feel about the rates), and somehow we all muddle through.