Determining Tax Deficiencies
As we discussed a few weeks ago,[i] the IRS is charged with enforcing the U.S. federal tax laws; i.e., it is responsible for processing tax returns and for collecting taxes. As part of its collection function, the agency may examine a taxpayer’s books, accounts, financial and other records to ensure that the information included on the taxpayer’s return for a tax year was reported correctly, and to verify that the reported amount of tax was correct.
Where the IRS determines that a taxpayer did not report the correct amount of tax – i.e., where there is a deficiency – the IRS will propose changes to the taxpayer’s return and calculate the “correct” amount of tax owing based upon such changes.
If a taxpayer disagrees with the IRS’s findings or conclusion, there are several means available by which the taxpayer may defend their tax return as filed and to challenge the IRS’s determination.
The Clock is Ticking
Throughout the foregoing process of determining the correct amount of tax owed by a taxpayer for a particular tax year, the IRS is aware that it has only a limited period of time – i.e., the statutory limitations period – within which to assess and then collect any additional amount of tax owed by the taxpayer for that year.
Extending the Period . . . or Not
If the IRS determines that there is not enough time remaining in this limitations period, the agency will request that the taxpayer agree to extend the limitations period to a specific date.[ii]
If a taxpayer refuses to agree to an extension, the IRS will take steps to assess any tax it has determined to be due; specifically, it will issue a notice of deficiency describing the basis for the IRS’s determination that an additional amount of tax is due, and informing the taxpayer that they have 90 days from the date of the letter to either agree to the asserted deficiency or file a petition with the Tax Court for a redetermination of the proposed deficiency.[iii]
If the taxpayer fails to timely petition the Tax Court, the IRS will assess the amount of the asserted deficiency and begin taking steps to collect the tax.[iv]
The Limitations Period – Policy
The limitations period[v] is the period of time established by Congress during which the IRS may examine a taxpayer’s return for a particular tax year, determine whether the taxpayer owes any additional tax for such year, and then assess the amount of such additional tax. After the tax has been assessed, the IRS may seek to collect the tax (plus interest and any applicable penalties).[vi]
When this statutory assessment period expires, the IRS can no longer assess, and then collect, additional tax from the taxpayer for the year in question.
Why is that?
Defending the Return
The limitations period is a statutory limitation on the collection of a tax deficiency if such deficiency is not assessed within a specified number of years after the filing of a tax return for a particular year. This deadline for assessment is somewhat arbitrary, as most limitation periods are.
That said, the limitations period may be described as a safeguard against the possibility that the IRS may delay its examination of a taxpayer’s return to the point where the taxpayer and/or their advisers may not be alive, may no longer remember the facts reported on the return, or may no longer have in their possession the returns, workpapers, transaction documents, and other materials that could have been used to support a position taken on the taxpayer’s return, thereby prejudicing the taxpayer.[vii]
In other words, the delayed examination of a taxpayer’s return may effectively deprive the taxpayer of the means for defending such return.
Closure
A related reason for the limitations period is to provide the taxpayer with a degree of certainty as to the status of their return and their tax liability.
For example, imagine that many years after the timely filing of a tax return and payment of the tax shown thereon as owing, the IRS examines such return and makes certain revisions thereto, the effects of which are carried forward over several years, resulting in additional tax deficiencies (including interest and, perhaps, penalties) not only for the year examined but also for such later years.
The deadline imposed by the limitations period on the assessment of tax may reduce the amount of interest and penalties owing by the taxpayer for the year in question by compelling the IRS to identify potential issues not long after the filing of the return. Moreover, any adjustments made by the IRS for the year in question may afford the taxpayer an opportunity to self-correct (i.e., amend) later-year returns.
Assessment Period
In general, the IRS may assess a tax deficiency against a taxpayer within the three-year period that begins on the due date for filing the taxpayer’s return (including extensions)[viii] or, if later, the date on which such return is filed.[ix]
If the IRS fails to assess additional tax within this period, the agency may be barred from collecting it.
Fraud Exception
That said, there are several exceptions to this general rule.[x]
One of these exceptions provides that the IRS may assess tax “at any time” where “a false or fraudulent return” has been filed “with the intent to evade tax” (the “fraud exception”).[xi]
Stated differently, the Code suspends the running of the limitations period on assessment in the case of a false or fraudulent return, which makes sense because fraud places the IRS in a “disadvantageous position” vis-à-vis the determination of a taxpayer’s correct tax liability.[xii]
Whose Intent?
The U.S. Court of Appeals for the Third Circuit recently considered the following question: whose “intent” to evade tax is required in order for this exception to the statute of limitations to apply?[xiii]
Seems like a silly question, you say? Shouldn’t the extension of the limitations period, which would enable the IRS to assess a tax deficiency against a particular taxpayer with respect to the return they filed for a particular tax year, be dependent upon that taxpayer’s intent to evade tax? After all, it is the taxpayer’s liability with which the IRS is concerned. Thus, if that taxpayer intended to file a false return, the extended limitations period would apply.
Alternatively, what if the taxpayer whose tax liability is at issue did not have the requisite intent to evade tax, but a false or fraudulent return was nonetheless filed on behalf of the taxpayer?
In the absence of such intent, you may ask, isn’t the IRS out of luck in collecting the correct amount of tax? In that case, how and why would the fraud exception to the regular three-year limitations period apply?
Does it matter that, unbeknownst to the taxpayer, someone other than the taxpayer filed, or caused to a filed, a fraudulent return on behalf of the taxpayer?
Surprise (?)
According to the Third Circuit – and probably to the surprise of many – the absence of bad intent on the part of the taxpayer is irrelevant; the fraud exception may still apply under these circumstances to allow the IRS to assess additional tax against the “innocent” taxpayer.
In the case before the Court of Appeals, it was the taxpayer’s return preparer who prepared such return with an intent to evade tax. The fact that the taxpayer did not share, or was even aware of, such intent did not preclude application of the fraud exception to the limitations period.
After telling the taxpayer that it understood their frustration with the IRS’s decision to assess tax beyond the limitations period due to the wrongdoing of someone other than the taxpayer, the Court added that its hands were tied. “[We] are bound by the statute,” the Court stated, and “because the statute is agnostic about who must intend to evade tax, we hold that taxpayer intent is not required.”
An Unsuspecting Taxpayer
Taxpayer underpaid their taxes for seven tax years because their tax preparer placed false or fraudulent information on Taxpayer’s tax returns for those years with an intent to evade tax.
Taxpayer did not cause the false or fraudulent entries, did not provide false or fraudulent information to the return preparer, did not know of the preparer’s false or fraudulent entries, and did not intend to evade tax.
Twenty Years Later (!)
The IRS discovered the preparer’s fraudulent entries over 20 years later – yep, that’s right – at which point the IRS issued a notice of deficiency to Taxpayer regarding the underpayments for those seven years.
Taxpayer filed a petition in the U.S. Tax Court for a redetermination of the asserted deficiency. Taxpayer agreed with the IRS that there were underpayments for the years in question. In addition, Taxpayer did not dispute the application of an accuracy-related penalty, or the imposition of interest, with respect to the underpayments.
Taxpayer argued, however, that none of the foregoing was relevant because the IRS did not act within the three-year limitations period. According to Taxpayer, the fraud exception applies only where the taxpayer has filed a false or fraudulent return with the intent to evade tax. Because that was not the case, the notice of deficiency was issued late and, thus, the IRS was barred from assessing and collecting the tax asserted therein.
Tax Court
The Tax Court disagreed with Taxpayer’s argument.
It began by stating that “limitations statutes barring the collection of taxes otherwise due and unpaid are strictly construed in favor of the Government.”
The Tax Court then rejected Taxpayer’s analysis, pointing out that the fraud exception “does not restrict its application to cases where taxpayers personally had the intent to evade tax.” The Tax Court also added that the “specification of whose tax or return is at issue” – i.e., the taxpayer’s – “does not suggest, much less dictate, who had to intend to evade the tax.”
With that, the Tax Court held that the fraud exception applied to Taxpayer’s false or fraudulent returns for the seven years in question because Taxpayer’s return preparer entered false or fraudulent information to prepare Taxpayer’s returns with an intent to evade tax. Thus, the three-year limitations period did not bar the IRS’s notice of deficiency or the assessment of the additional tax.[xiv]
Taxpayer asked the Court of Appeals for the Third Circuit to consider the Tax Court’s holding.
Third Circuit’s Analysis
After reviewing the three-year limitations period, the Court turned to the fraud exception, which reads in relevant part as follows: “[i]n the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed . . . at any time.”
To determine whether taxpayer intent is necessary to trigger the indefinite limitations period for a false return, the Court began by restating the question before it as whether the “intent to evade tax” component of the fraud exception necessarily required taxpayer intent.
Taxpayer’s Intent
The Court noted that the text of the fraud exception neither stated nor implied that the phrase “intent to evade tax” was restricted, or could referred only, to the taxpayer. Instead, the “structure of the statute,” the Court stated, focused solely on the presence of “a false or fraudulent return with the intent to evade tax.”
What’s more, the Court continued, nothing in the legislative history of the fraud exception indicated that the taxpayer had to be the actor who intended to evade tax by filing a false or fraudulent return.
Obligation Owed?
Instead, the Court stated that the phrase, an “intent to evade tax,” means that someone planned to avoid an obligation owed by an individual or entity to the government.
While an “intent to evade” concerned the taxes owed by a taxpayer, the Court stated “the plain meaning of the words” of the fraud exception “does not imply a specific actor.”
“Passive Voice”?
Next, the Court observed that Congress used a “passive voice” in that it drafted the fraud exception by focusing “on an event that occurs without respect to a specific actor, and therefore without respect to any [specific] actor’s intent or culpability.”
According to the Court, this indicated that the exception did not depend on a taxpayer’s intent. By wording it this way – i.e., without listing who must intend to evade tax – “Congress was agnostic,” the Court opined, about who did so to trigger the exception.
Taxpayer’s Position
Taxpayer responded that because the tax evaded was that owed by a taxpayer, the plainest reading of the phrase “intent to evade tax” must refer to such taxpayer’s conduct. Any other reading, Taxpayer argued, “would unnaturally interpret the statute contrary to any commonsense interpretation of it.”
According to Taxpayer, “the plainest reading of [the fraud exception] is that the statute refers to the intent of the person with the legal duty to file the tax return and pay the tax: the taxpayer.”
In addition, Taxpayer argued that, by not limiting the fraud exception to a taxpayer’s intent, the Court would “offend basic due process and fairness principles by not defining whose intent might matter.”
The Court conceded that Taxpayer’s “argument is a fair one.” And “it certainly is true,” the Court stated, “that [the fraud exception] applies when a taxpayer intends to evade tax. That much is beyond debate.”
Still, the Court explained that “the plainest and most straightforward reading of [the fraud exception] is that it simply requires an intent to evade tax attached” to a false or fraudulent return, and “whether a taxpayer, accountant, lawyer, or tax preparer evinced such intent is beside the point.”
In response to Taxpayer’s “due process” argument, the Court observed there was no need to “determine the outer bounds of how an intent to evade tax” applied in every context because Taxpayer had stipulated that their tax preparer intended to evade Taxpayer’s taxes.
Nonsensical? You can bet Taxpayer thought so.
Congress Knows How to Draft
Moreover, according to the Court, Congress knows how to limit statutes to taxpayers when it intends to do so; then it cited a number of examples to make its point.
In the case of the fraud exception to the regular three-year limitations period, the Court stated that Congress did nothing to limit application of the exception to a taxpayer’s intent.
The fact that the tax return at issue is the taxpayer’s does not necessarily imply, the Court explained, that “the fraudulent intent referenced . . . is by implication limited to fraud by the taxpayer.”
The Code merely requires that the intent to evade tax must be present in a false or fraudulent return in order for the fraud exception to apply, regardless of who possesses that intent.
The fraud exception, the Court repeated, does not identify who must intend to evade tax. It focuses on an event without regard to an actor – that is, Congress focused on a “false or fraudulent return with the intent to evade tax” without saying who must act. According to the Court, “[by] pulling the taxpayer off the stage, Congress made its reasoning clear.” The limitations period does not apply when someone intends to evade tax in the filing of a false or fraudulent return, taxpayer or not. Common law fraud principles, the Court added, “establish that innocent people are sometimes held liable for fraud they did not personally commit.”
The Court explained how its holding continued “the well-trod ground laid by the Tax Court” in which the fraud exception was applied in situations beyond those in which a taxpayer intends to evade tax.[xv]
It then observed that the only other Circuit that had confronted this issue was aligned with the Court’s view.[xvi] The Court quoted the Second Circuit: “we conclude that the limitations period for assessing [the taxpayer’s] taxes is extended if the taxes were understated due to fraud of the preparer.”
With that, the Court affirmed the judgment of the Tax Court upholding application of the fraud exception.
Ouch.
Makes Sense?
In most cases, a taxpayer’s intent to evade tax may be obvious or may be deduced from the surrounding circumstances, including the actions of their return preparer.[xvii] The question of intent – and more particularly, whose intent – is not at issue.
Before addressing the question of intent, however, let’s consider the taxpayer’s obligations. I think we can all agree with the following:[xviii]
- a taxpayer is required to gather the information they will need to prepare their tax returns and determine their tax liabilities – this may include records on income received or accrued by the taxpayer and expenses paid or incurred by the taxpayer, as the case may be;
- using this information, the taxpayer is required to prepare tax returns that are “true, correct, and complete” to the best of the taxpayer’s knowledge and belief;
- the taxpayer is required to sign their returns under penalty of perjury;
- the taxpayer is required to file their completed returns properly and timely;
- they are required to keep and maintain complete and accurate records of their income and expenses that substantiate the information reported on their returns, as well as other documents that support the tax treatment of such items;
- the taxpayer is required to pay timely the taxes shown on such returns as owing;
- if the government successfully establishes that the taxpayer owes additional tax,[xix] then the IRS may assess such tax – provided it does so within the assessment limitations period – before proceeding to collect it.
Although most individual taxpayers nowadays prepare their own personal tax returns,[xx] almost every business, business owner, and sophisticated investor relies on a certified public accountant (“CPA”) to advise them on tax-related matters and to prepare, or assist in the preparation of, the taxpayer’s returns.
Taxpayers are regularly forewarned to conduct sufficient diligence before selecting a CPA to ensure the individual or firm in question is knowledgeable and experienced, and has a reputation for honesty and professionalism. After all, the taxpayer will be sharing a substantial amount of sensitive information with their CPA, and they want to be confident that their reliance on the accountant is well-placed.[xxi]
What’s more, the preparer will be primarily responsible for the overall substantive accuracy of the taxpayer’s return. Most taxpayers are not competent to discern error in the substantive advice of an accountant. Indeed, when an accountant advises a taxpayer on a matter of tax law, such as whether a liability exists, it is generally reasonable for the taxpayer to rely on that advice. To require the taxpayer to challenge the accountant, to seek a “second opinion,” or to try to monitor them on the provisions of the Code would nullify the very purpose of seeking the advice and assistance of a presumed expert in the first place.
That being said, the taxpayer is ultimately responsible for the accuracy of every item reported on their return. Again, the taxpayer signs their return under penalty of perjury, and they are presumed to know what is in their return. The taxpayer cannot abdicate that responsibility to the CPA.
How does one reconcile this responsibility with the degree of reliance described above, and how does it figure into the question of one’s intent to evade tax by filing a false or fraudulent return? Is it a question of whether a taxpayer acted in good faith, and provided complete and accurate information to the CPA? Was it reasonable for the taxpayer to rely on the accountant and the latter’s “judgement” under the circumstances?
What if the taxpayer has dotted and crossed the proverbial “i”s and “t”s, respectively, but still suspects something may be amiss? I am not referring to the more easily applied “too good to be true” test, or the equally tried and true “smell test” – these should rarely be overridden by a “well-reasoned” legal analysis, and the taxpayer’s intent to evade tax may be deduced from such circumstances.[xxii] I am talking about that degree of doubt that a reasonably intelligent business owner or investor experiences just before they ask “Are you sure?” followed by “If you say so.” At that point, it may behoove the business owner or investor to press their accountant to defend or clarify their analysis, but should the taxpayer’s failure to do so support application of the fraud exception?
Then again, there are situations in which a preparer may effectively conceal their improper activities from the taxpayer. In such a situation, does it make sense that the government may apply the fraud exception to the limitations period for assessment by relying upon the preparer’s intent to evade tax? I think not.
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] https://www.taxslaw.com/2025/09/responding-timely-to-a-90-day-letter-is-it-jurisdictional/#_edn10.
[ii] IRC Sec. 6501(c)(4). No longer than is necessary to properly complete the examination and any administrative action necessary to process the taxpayer’s case. In some cases, the IRS and the taxpayer may agree to extend the limitations period with respect to only a specific item on the return.
[iii] IRC Sec. 6212, Sec. 6213.
It should be noted that the limitations period within which the IRS may assess additional tax is suspended during the 90-day filing period and, assuming the timely filing of a petition, for 60 days after a final Tax Court decision. IRC Sec. 6503. It isn’t difficult to see that during the time frame that includes the examination, the voluntary extension of the limitations period during the examination, the petition to the Office of Appeals, the Appeals hearing, the petition to the Tax Court, the Tax Court trial, and perhaps the appeal to a Circuit Court, the interest on the deficiency may reach astronomical heights.
[iv] But see https://www.taxslaw.com/2025/09/responding-timely-to-a-90-day-letter-is-it-jurisdictional/.
[v] Or statute of limitations.
[vi] The collection of tax has its own limitations period. IRC Sec. 6502.
[vii] The taxpayer has the burden of supporting the information presented and any positions taken on its tax return.
[viii] The IRS is authorized to grant a “reasonable extension of time” for filing returns. Except in the case of taxpayers who are abroad, no such extension may exceed six months. Taxpayers must generally submit a written application for the extension on or before the due date of the return. IRC Sec. 6081(a).
[ix] IRC Sec. 6501(a).
[x] One was mentioned earlier: Where, before the expiration of the time prescribed for the assessment of any (except the estate tax) the IRS and the taxpayer consent in writing to extend the period for assessment of tax after such time. The IRS is required to notify the taxpayer of their right to refuse to extend the period of limitations, or to limit such extension to particular issues or to a particular period of time. IRC Sec. 6501(c)(4).
[xi] 6501(c)(1). “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.”
It should be noted that a taxpayer cannot purge a fraud committed on an original tax return by filing a completely accurate and truthful amended return. Once the fraud is committed by the filing of an original return, the offense is completed. United States v. Habig, 390 U.S. 222 (1968).
[xii] Badaracco v. Commissioner, 464 U.S. 386 (1984).
[xiii] Murrin v. Comm’r, Case Number 24-2037 (3rd Cir. 2025).
[xiv] Murrin v. Comm’r, T.C. Memo. 2024-10.
[xv] See, e.g., Allen v. Comm’r, 128 T.C. 37 (2007) (applying IRC Sec. 6501(c)(1) because of a tax preparer’s intent to evade tax).
[xvi] City Wide Transit, Inc. v. Comm’r, 709 F.3d 102 (2d Cir. 2013).
[xvii] In those cases, the accountant may even be viewed as the taxpayer’s agent or co-conspirator.
[xviii] At least I hope we can. It seems that even the mention of the most innocuous of items can turn into a contentious debate these days.
[xix] Again, the taxpayer has the burden of demonstrating that their returns are correct.
[xx] Commercially available software.
[xxi] In the case of a closely held business or investment firm, it may behoove the owners to implement internal controls to ensure the accountant is behaving, and to protect against a rogue employee. However, should a taxpayer’s failure to establish such controls open the door to application of the fraud exception to the limitations period?
[xxii] Consider the case of the Bronx tax preparer, Rafael Alvarez, who was so prolific in falsifying his individual customers’ tax returns for over a decade that he came to be known as “the Magician” for his ability to make customers’ tax burdens disappear, and often generating refunds for them. The government was able to establish that Alvarez committed criminal tax fraud by preparing false and fraudulent tax returns on behalf of his customers. He agreed to pay millions of dollars in restitution to the IRS. It remains to be seen whether the government will pursue any of his customers.
