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Auditing Back Taxes: Congress Overrules IRS on Overstatement of Basis Issue

February 6, 2016


David Bowie’s recent death has revived interest in his work, including the classic song “Changes.”

“Ch-ch-ch-ch-changes / (Turn and face the strange),” the Thin White Duke crooned in 1971. He wasn’t singing about tax law, but U.S. taxpayers certainly face plenty of tax law changes every year.

In this post, we will inform you about one of them: an increase in the IRS’s ability to go back in time to audit old tax returns.

The look-back period for tax audits is a subject we’ve explored before. As we noted in our April 10 post last year, the general rule is that the IRS can go back six years.

There are several exceptions to this. If the IRS finds a substantial error on your return, it could go back six years. The IRS could also ask you to agree to extend the limitations period by your own choice so that further documentation can be gathered.

What constitutes a substantial error? The guideline has long been that such an error involves omitting a quarter or more of your income.

What does it mean to “omit” income? In 2012, in a case called U.S. v. Home Concrete & Supply, the U.S. Supreme Court held that overstating the basis on a sale of property is not equivalent to an omission in the reporting of income. In cases such as this, the Court ruled, the IRS can only go back three years for tax audits.

As Forbes reported last month, however, Congress has overruled the Supreme Court on what constitutes omission of income. The result is a change in tax law, giving the IRS more authority to audit back taxes in certain cases.