Every statute of limitations in the tax code has a reason behind it. The three-year assessment rule exists because the IRS has a fair chance to review a return in three years. The fraud exception exists because a fraudulent return is designed to defeat that review. So Congress removed the limit.

This guide covers the civil assessment rule only: what the statute says, what the IRS has to prove and why fixing a fraudulent return later does not shut the door. If you are worried about criminal exposure, stop reading guides and talk to a lawyer before you talk to anyone else.

The statute

Section 6501(c)(1) of the Internal Revenue Code says that 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.

Section 6501(c)(2) adds a parallel rule for a willful attempt in any manner to defeat or evade tax, other than income, estate and gift taxes, which are covered by paragraph (1). That second rule reaches employment and excise taxes where the evasion takes some form other than a false return.

The key phrase is intent to evade. A wrong return is not enough. A careless return is not enough. Even a return that leaves out a lot of income is not enough by itself; that situation is handled by the six-year omission rule. Fraud requires intent.

The IRS has to prove it

Fraud is the IRS's burden. In Badaracco v. Commissioner, 464 U.S. 386 (1984), the Supreme Court noted that fraud cases differ from other civil tax cases in that it is the Commissioner who has the burden of proof on the issue of fraud, citing IRC 7454(a). That burden is the taxpayer's best friend in a late-arriving fraud case.

The Internal Revenue Manual describes how the IRS looks at it. IRM 25.6.1.9.5.2 lists indicators of fraud, such as substantial unexplained increases in net worth, personal spending well beyond known resources and bank deposits from unexplained sources that substantially exceed reported income. It distinguishes those indicators from affirmative acts, such as concealing bank accounts, omitting specific items while including similar ones and failing to deposit receipts into business accounts.

The same IRM section describes fraud as actual, intentional wrongdoing, done with the specific purpose of evading a tax believed to be owed. Indicators raise a question. Proof answers it. The distance between the two is where these cases are fought.

Badaracco: an honest amended return does not restart the clock

People who filed a false return and later regret it often ask whether filing a correct amended return starts a fresh three-year period. The Supreme Court answered that in Badaracco.

The taxpayers in that case conceded their original returns were fraudulent. They later filed nonfraudulent amended returns and paid the tax shown. Years later, the IRS issued notices asserting the fraud penalty. The taxpayers argued the amended returns started the normal three-year period, which had expired.

The Court disagreed. It held that the plain language of section 6501(c)(1) permits the IRS to assess at any time the tax for a year in which the taxpayer filed a false or fraudulent return, despite any subsequent disclosure. The Court reasoned that the return referred to in section 6501(a) is the original return, not an amended one, and that an amended return is a creature of administrative origin and grace rather than something the Code requires. It also pointed out that a contrary rule would put a fraudulent filer in a better position than an honest taxpayer who innocently omits more than 25 percent of income and is stuck with six years.

The IRS applies the same rule. IRM 25.6.1.9.5.2 says an amended non-fraudulent return submitted after a fraudulent return does not begin the period of limitations, citing Badaracco.

Fraud versus no return

Badaracco also drew a line that matters. The taxpayers argued it was unfair that a person who fraudulently fails to file can start the clock by filing late, while a person who files a fraudulent return cannot cure it. The Court acknowledged the difference and held that it follows from the statutory language.

Section 6501(c)(3), the no-return rule, applies to a failure to file a return. The Court said it is settled that this provision ceases to apply once a return has been filed, even late. Section 6501(c)(1) applies to a false or fraudulent return, and a later amended return does not make the case any less one of a false or fraudulent return. Two different exceptions, two different cures. More on the first one is in the guide to unfiled returns.

Joint returns

On a joint return, the fraud of one spouse can keep the year open for both. IRM 25.6.1.9.5.2 says that in the case of a joint return, the fraud of one spouse will keep the assessment period open with respect to both spouses.

That does not mean the innocent spouse is stuck with the result. Relief from joint liability is a separate body of law with its own rules and deadlines, covered in the library article on equitable relief. The point here is that the statute of limitations may not protect the innocent spouse on its own.

What this means in practice

If the IRS raises a year that is many years old and no other exception applies, fraud may be the only theory keeping it open. That is a heavy lift for the IRS. Your response should focus on the elements: what exactly was false, what evidence shows intent, and whether the facts are better explained by mistake, bad advice or poor records.

If the IRS cannot prove fraud for that year, the fallback is usually the six-year rule, and if the omission does not meet the 25 percent test, the year may be closed. Test every layer.

If you know a prior return was false, do not assume an amended return solves the statute problem. Badaracco says it does not. Do not assume it is harmless, either, because an amended return can be an admission. The order of operations matters, and the decision about how to come forward should be made with counsel.

Questions to ask when the IRS raises an old year

When a notice or an examiner points to a year well past the normal deadline, slow down and take the questions in order. The answers tell you whether the fight is about the statute, about the facts or both.

  • Which exception is the IRS relying on? Fraud under IRC 6501(c)(1), the six-year omission rule under IRC 6501(e), an unfiled return under IRC 6501(c)(3) or a signed consent under IRC 6501(c)(4) each has different elements.
  • If it is fraud, what specific facts does the IRS say show intent? Indicators are not proof, and the IRS carries the burden.
  • If the fraud theory fails, does the omission still exceed 25 percent of the gross income stated on the return? If not, the year may be closed.
  • Was the return a joint return, and if so, whose conduct is at issue?
  • Is there any criminal dimension to the inquiry? If there is, the civil statute question is the smaller problem, and the response needs to be handled by counsel.

Answering those questions before you answer the IRS keeps you from conceding the one point that keeps the year open.

The bottom line

A false or fraudulent return with intent to evade tax has no assessment deadline under IRC 6501(c)(1). The IRS carries the burden of proving fraud. An honest amended return does not restart the three-year clock, under Badaracco v. Commissioner, 464 U.S. 386 (1984). On a joint return, one spouse's fraud can keep the year open for both.

The statute is unforgiving here. The burden of proof is not. That is where the defense starts.