Tax Court Update – January 2009 – Statute of Limitations on Assessment

David Loeb v. Commissoner of Internal Revenueand Harold Molaison v. Commissioner of Internal Revenue (Consolidated) – The issue for decision in these consolidated cases was whether the statute of limitations barred the IRS’ issuance of the Notices of Deficiency.

IRC § 6501(a) provides,

Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed . . . and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period.

§ 6501(c)(1) contains an exception to this rule (statute of limitations on assessment):

In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.

Judge Haines concisely articulated the dispute:

Petitioners contend that the 3-year period of limitations on assessment in section 6501(a) expired before respondent issued the notices of deficiency and respondent’s assessment is barred. Respondent argues that the period of limitations in section 6501(a) does not apply because petitioners filed false or fraudulent returns with the intent to evade taxes for 1996. See sec. 6501(c)(1).

The United States had prosecuted the taxpayers on the grounds that they had committed criminal fraud by filing false 1996 tax returns. but at trial the taxpayers were acquitted of all criminal charges.

Judge Haines noted that a criminal conviction is not required under § 6501(c)(1) because the criminal standard of guilt is “beyond a reasonable doubt” and the standard for purposes of § 6501(c)(1) is the lower bar of “clear and convincing evidence.” 

In order to show fraud [under 6501(c)(1)], respondent must prove: (1) An underpayment exists; and (2) petitioners intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes.

The Judge then applied the “badges of fraud” test used by the courts in § 6663(a) cases and ruled that,

As a result of the paucity of badges of fraud in this case, we find that respondent has failed to show by clear and convincing evidence that petitioners filed their 1996 returns with the intent to evade tax. Therefore, the 3-year period of limitations under section 6501(a) applies to petitioners’ 1996 tax year, and respondent is barred from assessing any deficiencies in petitioners’ tax for that year.

Author’s Advice: The key thing for practitioners to remember about this case is that, should the IRS assert a civil fraud penalty and it sticks, the 3 year statute of limitations on assessment won’t apply and an assessment may be made by the IRS against the taxpayer “at any time.”

Practitioners should never recommend that their clients agree to the IRS’s imposition of a civil fraud (§ 6663(a)) penalty.