New Tax Code Language Retroactively Affects Returns

Posted by: Brookside Admin

Each year, the U.S. Tax Code undergoes changes. These can range from subtle to significant and, at times, drastically alter the way you calculate your tax liability or offer new opportunities for write-offs and deductions. Knowing when these changes occur and understanding how they affect you is important in order to pay your taxes fully and take advantage of any opportunities for discounts. That's where working with professionals like the CPAs at Brown Kinion and Company pays off. We know the laws, study the changes and apply our knowledge to each of our clients' individual situations. A recent change could affect not only next year's returns, but also retroactively apply to returns submitted in the previous few years. Here's what individuals and business owners need to know about an increased statute of limitations for an IRS audit. 

  • Time limit for an audit

Once you've filed your return, the IRS doesn't have to notify you that you'll be audited right away. They generally have three years to find mistakes in your return and conduct an audit. In certain situations, that time limit can be expanded to up to six years, however. Specifically, this occurs if a "substantial understatement of income" is detected. This is defined as failing to report at least 25-percent of your income, or only filing 75-percent or less of your income. Within these guidelines, there are some ambiguities that have opened loopholes and been the subject of litigation. In 2012, a landmark case set precedent for specifying these guidelines. 

  • US v. Home Concrete & Supply, LLC

In this Supreme Court case, a taxpayer was found to have omitted gross income in excess of 25-percent of his total actual income. Under typical circumstances, that would seem to allow the IRS to audit within a six year period. However, in this case, the taxpayer made an overstatement of basis of property, which resulted in the understatement of taxable income. The Fourth Circuit Court of Appeals ruled that these circumstances did not trigger the extended audit period. The Supreme Court case backed up that ruling, which then set the groundwork for a formal changing of the Tax Code by Congress. 

  • The new Tax Code

With Congress disagreeing with the Supreme Court's decision, they set to work to change the language in the Tax Code to eliminate this loophole and make the guidelines more clear. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 added this statement to the Tax Code: 

"An understatement of gross income by reason of an overstatement of unrecovered cost or other basis is an omission from gross income."

This explicitly extends the audit window in cases similar to Home Concrete & Supply. While the change applies to all returns filed after July 31, 2015, it also retroactively applies to any returns still open under the statute of limitations. This means recent tax returns filed that contain an understatement of income in excess of 25-percent will still be subject to the the new Tax Code language, even though at the time of filing, that language didn't exist. 

Because of changes like this, you need a professional on your side that's continuously immersed in tax law. Call the CPAs at Brown Kinion and Company for help filing your individual or business return and tax planning