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Extended Statute of Limitations for Unreported Income Does not Apply to Gross Income for Failure to Report Foreign Financial Assets before Enactment of IRC 6038D

Posted on Jan. 26, 2018

In a precedential opinion, the Tax Court in RAFIZADEH v. Commissioner, 150 T.C. No. 1 (2018) held that the petitioner’s failure to report income from foreign financial assets did not hold open the statute of limitations on assessment. Because the IRS took more than three years after the timely filing of his returns for the years at issue before it issued the notice of deficiency, the statute expired prior to the notice. The taxpayer won a complete victory. The case is narrow in its holding and the tax years to which it applies have now run, but the victory is certainly important for this taxpayer and perhaps for others whose foreign income was discovered through the use of summons after the ordinary statute of limitations had expired.

Petitioner timely filed his 2006 through 2009 returns. It seems rare to state someone timely filed their returns in this blog even though timely filing is the norm for the vast majority of taxpayers. The timely filing of the returns proves important for petitioner here. On the timely filed returns petitioner did not report income earned on a foreign account that he owned. That unreported income forms the bases of the notice of deficiency that the IRS ultimately sent.

Over the past 15 or more years, the IRS has used John Doe summonses to obtain information about U.S. taxpayers with accounts overseas. It issued such a summons at some point and obtained information on November 16, 2010. The receipt of information from a John Doe summons is a starting point and not an ending point. Once the information is received, it can take the IRS quite some time to process that information and match it with specific taxpayers. In this case it took four years from the receipt of the John Doe information until the issuance of a notice of deficiency to petitioner on December 8, 2014, with respect to the tax years 2006-2009. In the notice the IRS asserted accuracy related penalties but did not assert the fraud penalty.

Had it asserted the fraud penalty, and had it succeeded in proving fraud in the failure to report the income from the foreign based assets, the statute of limitations would have remained open based on the fraud exception, which creates an unlimited time period within which the IRS can assess. Instead, the IRS argued that the statute was held open by the six year statute of limitations found in IRC 6501(e)(1)(A)(ii) which applies in situations in which the taxpayer omits “specified foreign financial assets” required to be reported by IRC 6038D.

The issuance of the John Doe summons suspended the running of the statute of limitations pursuant to 7609(e)(2)(A), but because of its resolution in 2010, that suspension was insufficient to keep the statute open until the issuance of the notice of deficiency. In order to keep the statute open until the notice of deficiency was issued, the IRS needed the special provision related to foreign assets which was not enacted until March 18, 2010. I assume from the lack of discussion that the amount of the omitted income was insufficient to trigger the six year statute of limitations based on a 25% omission of gross income. The liabilities in the notice, which range from $10,934 to $1,619, suggest that the amount of omitted income was not huge.

Section 6038D is effective for taxable years beginning after March 18, 2010 which was the date of its enactment. Section 6501(e)(1)(A)(ii) applies to returns filed after March 18, 2010, and also to “returns filed on or before …[March 18, 2010] if the period specified in section 6501 of the Internal Revenue Code of 1986 (determined without such regard to such amendments) for assessment of such taxes has not expired as of such date.”

Petitioner argues that the effective date of section 6038D precludes the application of the six year statute of limitations. Specifically, petitioner argues that the phrase in section 6501(e)(1)(A)(ii) which states “assets with respect to which information is required to be reported under section 6038D at the time the income was omitted” requires that the extension only apply to years after the effective date of 6038D. Since petitioner did not have a requirement under section 6038D to report these assets for the tax years 2006-2009, he could not have trigger the six year period under the complimentary statute.

The Tax Court agrees with the petitioner, stating “we must give effect to all of the words in the key phrase before us – ‘assets with respect to which information is required to be reported under section 6038D.’” The Court finds that even though the effective date of section 6038D was not imported by the cross-reference to section 6038D, the most natural reading of the phrase is that the six year statute only applies if a section 6038D reporting requirement exists.

The IRS also argued that the reporting requirement in section 6501(c)(8) shows that Congress did not link the statute extension in section 6501(e)(1)(A)(ii) to the failure to satisfy section 6038D, but the Tax Court does not buy this argument finding instead that the failure to report under section 6501(c)(8) has its own limitations period. The Court points out that it addressed a similar statute of limitations issue involving cross referencing in the case of Blak Invs. v. Commissioner, 133 T.C. 431 (2009). In that case, the issue was section 6707A and the limitation period in section 6501(c)(10). The Court finds the decision in Blak instructive. In section 6501(c)(10), Congress used the phrase “for any taxable year” but in section 6501(e)(1)(A)(ii) the language does not broaden to “any” taxable year. The statute in Blak also involved a preexisting obligation to report information whereas in this case petitioner had no preexisting duty to report the information now required by IRC 6038D.

The case is precedential because it decides a matter not previously addressed by the Court. The issue is unlikely to arise in the future now that we are seven years into the reporting requirements of section 6038D. The statutory analysis used to reach the conclusion in the case may be useful to others seeking to attack a statute of limitation extension. Congress has demonstrated a willingness in recent years to create an extended statute for new reporting requirements. To the extent you are faced with a similar situation, the RAFIZADEH case provides a possible path to victory.

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