Understanding Tax Refunds, IRS Audits, and Collections

tax audit puzzle
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The Internal Revenue Service has plenty of time to make sure your tax situation is on the up-and-up. The tax code gives the IRS three years to audit your tax return and 10 years to collect any tax you owe. It also sets a deadline for you—when you must file your return if you want to collect your refund. Together, these laws are called statutes of limitations.

You Have 3 Years to Claim a Tax Refund

You have three years from the date of the original deadline of the tax return to claim your refund. For example, your 2018 tax return is due on April 15, 2019. If you add three years to this filing deadline, you have until April 15, 2022, to file your 2018 tax return and still get a tax refund. If you wait any later than that, your refund "expires." It goes away forever because the statute of limitations for claiming a refund has closed.

Amended returns claiming additional refunds must be filed with the IRS before the three-year statute of the limitations expires, which would be the April 15 due date—unless you filed an extension. This extends the statute of limitations to October of that year, which is effectively the new due date after you've asked for an extension. The IRS can issue refunds for a particular year if you request an extension and subsequently file a tax return within three years from the extended deadline.

There are two exceptions to the three-year statute of limitations on refunds:

  • Taxpayers have up to seven years to claim a refund resulting from deductions for bad debt or worthless securities.
  • The three-year statute of limitations does not apply in situations where taxpayers are unable to manage their financial affairs due to physical or mental impairments.

So What Happens to Your Refund If You Don't Collect It?

When a refund expires, the federal government keeps the money. In IRS terminology, it's considered an "excess collection." That refund money cannot be sent to the taxpayer, nor can it be applied as a payment toward a future tax year. It can't be applied to another year as an estimated payment.

The IRS Has Three Years to Audit Your Tax Return 

This deadline is measured from the day you actually file your tax return unless you filed your taxes before the deadline. In this case, the clock doesn't begin running until the actual due date—April 15, 2019. So even if you file your return in February 2019, the IRS has until April 2022 to initiate an audit.

Most state tax agencies follow the federal three-year period for auditing tax returns, but some states have longer statutes of limitations.

There are three exceptions to the three-year federal rule on assessments and audits: 

  • The IRS has six years from the date a return is filed to audit a tax return and to assess additional tax if the taxpayer omits income that amounts to more than 25 percent of that which was reported on the tax return.
  • The IRS also has six years to audit a tax return and assess additional tax on income related to undisclosed foreign financial assets if the omitted income is more than $5,000.
  • The statute of limitations on audits and assessing additional tax remains open indefinitely if the taxpayer files a false or fraudulent tax return.

The IRS Has 10 Years to Collect Outstanding Tax Debts 

This is measured from the day a tax liability has been finalized, which can happen in a number of ways. Your liability may be considered finalized because it's the amount of tax reported on a tax return that you've filed, because it's an assessment of additional tax from an audit, or because it's a proposed assessment that has become final.

The IRS has 10 years to collect the full amount from the day a tax liability is finalized, plus any penalties and interest. If the IRS doesn't collect the full amount in the 10-year period, the remaining balance disappears forever because the statute of limitations has expired. You're off the hook.

The 10-year statute of limitations on collections can be suspended in the following situations:

  • While the IRS is reviewing an offer in compromise, installment agreement, innocent spouse relief, or collection due in processing the hearing.
  • While a taxpayer is under the automatic stay of bankruptcy protection plus an additional six months.
  • For periods when the taxpayer resides outside the U.S. for at least six months.

Using Time Limits to Plan Your Taxes

It's in your best interest to file your tax returns at your earliest possible convenience. First, you can claim any refund that is due you. Second, it starts the clock ticking on the three-year statute for audits and the 10-year statute for collections.

There are unique planning opportunities available to the filer if multiple tax years are involved because refunds that are still allowed under the three-year time limit can be used to pay off other tax debts owed to the IRS or applied to your current year's estimated taxes.