Forfeited Tax Refunds

There’s nothing worse when a taxpayer unintentionally forfeits their tax refund. Many are unaware that the U.S. tax law has a statute of limitations for someone to claim their tax refund. Forfeiture usually happens unintentionally because taxpayers file their returns late, after the statute of limitations.

The Internal Revenue Code forfeiture statutes are codified in section 6511 of the Internal Revenue Code, and any regulations the IRS has written to clarify these rules. The general rule is a taxpayer must claim the refund for their return within three years of the due date of the return, or two years after payment of the tax.

The three-year period of the due date means that you must file and claim the refund within three years of the original due date, or the extended date (in the event you file an extension).

EXAMPLE 1:

For the 2018 tax year, you file on the due date of April 15, 2019. In this case, you must make a refund claim by April 15, 2022.

EXAMPLE 2:

For the 2018 tax year, you file an extension for October 15, 2019 - you also file your return on the extended due date of October 15, 2019. In this case, you have three years after the extended due date, or October 22, 2022, to claim a refund.

EXAMPLE 3:

For the 2018 tax year, you file an extension for October 15, 2019 - however, you also file your return on the prior to the extended due date of October 15, 2019, filing your return on September 10, 2019. Since the IRS has received your return on September 10, 2019, the three-year period to claim a refund begins on this date. Therefore, you must claim a refund on or prior to September 10, 2022.

EXAMPLE 4:

For the 2018 tax year, you file on April 1, 2019, before the due date of April 15, 2019. In this case, you must make a refund claim by April 15, 2022, three years after the original due date. In this example, let’s say the IRS audits your return on October 1, 2021 and makes additional assessments against you, which you pay on November 1, 2021. If you later realize the IRS has made a mistake on their additional assessment, you have until two years (i.e. November 1, 2023) after the payment date to make a claim for a refund, although November 1, 2023 is after April 15, 2022.

Unless you can prove severe mental or physical disability (under Code section 6511(h)(2)), the three-year limit would apply and you will be denied your applicable refund. Code section 6511(h)(2) keeps the time to claim a refund open, but the taxpayer has a tough burden of proof under this section of the Code.

You may wonder why taxpayers unintentionally forfeit their refunds, which happens more often than you would think. In most cases, it’s due to non-filing until three years after the due date of the original return. In any case, we urge you to always file your taxes timely to avoid forfeiture of a refund, if you’re owed one. And remember, it is the taxpayer’s burden to prove timely filing of their claim for a refund. This is accomplished by an e-file receipt or courier tracking receipt.

THE MANY FACETS OF THE IRS STATUTE OF LIMITATIONS

The obligation to accurately report income taxes to the Internal Revenue Service is squarely on the shoulders of the taxpayer. However, the term “accurate” is the essential element here.

Consider taxpayers who have their own businesses, whether a Sole Proprietorship (Schedule C), flow thru entities such as Partnerships or S Corporations, or C Corporations. The mere declaration on these business returns of merely reporting the correct net income (bottom line) is not sufficient. The Internal Revenue Code has many statutes regarding the “Statute of Limitations” which quite simply means the time that IRS must select your return for audit, and thus attempt to make additional tax assessments against the taxpayer. This tax Code section 6501 has many parts to it.

The general rule, per the Code is the three year time frame for the IRS to audit and assess. This three year period is three years from the later of the original due date (usually April 15th) or later if the return is filed after April 15th , such as returns on extension or late filed returns. However, there are many twists an nuances to the Code section. One exception is failing to file a return or filing a “false” return. In these cases, the IRS has no time limit to audit and assess. Failing to file is a simple concept which means a taxpayer never files a return that is otherwise required to be filed.

A “false” return means substantial incorrect figures, which basically encompasses tax evasion. Mere over estimates of deductions, by estimating certain expenses, within a reasonable degree, for which the taxpayer has a reasonable basis, is not usually a basis to keep the statute open ended.

Another area that could extend, but not indefinitely extend, is under reporting gross business income by more than 25%. So, should a taxpayer not have exact figures on the net business income the taxpayer is advised not to merely estimate the net income but rather is advised to gross up sales and then list each type of expense. As an example, if a business return estimates the gross income/sales as $100,000 and expenses of $20,000 producing a net income of $80,000 but if IRS examines this return and finds that the summation of this net income is actually gross sales of $130,000 (with possible expenses of $50,000 (which still produces the same net income of $80,000)) IRS may invoke sub section 6501(e) under the Code. This is because the “gross income” or “gross sales” were under-reported by 30% ($30k not reported divided by $100k of sales reported). So, even if, at first glance, there may not be any change to the “bottom line” you are stuck with this examination and after almost six years it is much tougher to recall and compile receipts to support your expenses, much more than it would have been only after a three year period.

So, when filing your returns, each aspect of the return must be properly reported.

Federal Corporate Tax Rate 2018-2025

The Tax Cuts and Jobs Act of 2017 (the “Act”) lowered the federal corporate tax rate to 21%.

  1. The Act reduced the “C” corporation tax rate from 35% to 21%. Many think this tax break is solely meant for America’s largest corporations-which is not so. But, before a small business jumps onto the “C” corporation “band wagon” consider the following: Are you willing to leave profits in the corporation indefinitely?

  1. Remember, in comparison, an “S” corporation has very lax rules as to distributing funds. These shareholders may usually simply take residual cash/profits without any tax consequences. But a “C” corporation has stringent rules. Taking residual cash/profits from the “C” corporation can create DOUBLE taxation. This is because the entity structure does not allow for tax free distributions like an “S” corporation. If the “C” corporation shareholder pays him/herself residual cash/profits there is generally no corresponding deduction to the “C” corporation (so you have not reduced the “C” corporation tax at all) but you likely will be fully taxed, individually, upon you personally receiving this distribution, as a dividend, usually.

  1. Many times, the tax on this distribution will be at ordinary individual tax rates but with some careful tax planning the tax on these distributions (dividends) can be taxed at individual capital gains rates (from 0% to 20%, albeit most people are in the 15% capital gains bracket). Presuming you have structured this distribution at the 15% capital gains bracket you have effectively, as a small business person, paid a 36% tax on these distributions (21% at the corporate level since there is no deduction to the “C” corporation, plus the 15% personal tax rate you pay as an individual). And if this distribution is not structured under capital gain rates you could easily pay a 22% (the rate many Americans will hover around, personally) personal tax plus the 21% corporate tax, yielding a 43% total tax on these distributions.

  1. Thus, any time funds are paid out of a “C” corporation you should try and be sure there is a corresponding deduction at the “C” corporation level. Paying out bonuses to the owners triggers personal taxes to the recipient, at that person’s individual tax rate but also allows for a deduction at the corporate level. Shareholders may also pay out rents to themselves if the owners use their property for the corporation’s business-again taxable income to the individual and a tax deduction to the Corporation. The key here is to try and balance the competing tax rates. So careful planning is required to try and stay within the personal tax bracket of 22% (up to $82,500 for single persons and $165,000 for a married couple). Once you exceed these personal limits it does not make sense to have more income individually as the corporate deduction is only 21%.

Supreme Court-sales tax

Photo attribution: David Dugan/Wikimedia Commons.

Due to a 2018 U.S. Supreme Court case (Wayfair v S. Dakota), internet retailers can now be required to collect sales tax. The tough part is interpreting what this all means; how states will apply the right to tax internet retailers (e-tailers).

1. Some important things for businesses. Registration. Before a business can collect sales tax they must officially register to seek permission to collect sales tax within the state(s) they conduct business within. If a business merely collects taxes prior to registration there is usually large penalties. NY State-as an example-can impose a $10,000 fine.

2. Acquire proper software if you sell via internet that will track sales in multiple locations. You must, however, research to be sure the product/service you are selling via the internet is subject to tax in various jurisdictions. Charging tax when not required could create problems with your customers and certainly put you at an economic disadvantage. So, do not presume all states treat all products/services the same regarding sales tax applicability.

3. Of course, do not jump into registering in all 50 states to collect sales tax, just because you are an e-tailer. The South Dakota law reviewed by the U.S. Supreme Court had a de minimis exemption in the law; under $100,000 in annual sales and less than 200 transactions in the state. Simply stated; if you did not meet those limits you are not required under the South Dakota law. to collect any sales tax. This does not mean other states must follow suit and exclude the same amounts but likely a drastic change of these exemptions would cause a state law to be unconstitutional because of the “burden on interstate commerce”, which the Courts are always concerned about.

4. An income tax requirement is now born in all these states. In addition to registering for sales tax in required states an internet e-tailer would need to register with that same state’s Department of State. This is required so the business has the legal authority to conduct business in that state. Consequently, if you are doing business in any state you are also required to file an income tax return, whether you are structured as a Corporation or Limited Liability Company. This of course truly increases the burden on internet companies not only in tax payments but in administrative costs for filing multiple income and sales tax returns.

5. So take a deep breath and conquer each item methodically. And hope that maybe Congress will intercede. Congress may be able to legislate this away and possibly create a uniform sales tax rate for e-trailers throughout the country and disburse the collections based on a formula of population or on the volume of sales from within each state. This would, however, not eliminate the need to file income tax returns in multiple states, but could eliminate the sales tax registration in the particular states.