Latest / VoraPrep Audio — Professional Licensure & Certification Exam Prep / [CPA] REG: IRS Procedures and Penalties: Mastering Statutes of Limitation and Audits
Transcript
- Hey, welcome to VoraPrep Audio. Alright, let's talk about something that shows up on the exam all the time, but also... it's the stuff of real-world CPA nightmares. Picture this. It's late April, 2026. You're deep into the current tax season, and you get a call from one of your best clients. They are panicking. The IRS just sent them a notice proposing a huge tax bill for their 2022 return. The CEO is on the phone saying, "Can they even do this? We filed that return over three years ago!" Your answer in that moment… that's where your real value is. It's the difference between your client writing a massive check to the IRS, or you telling them, "Don't worry, they're too late." This isn't just theory. This is the game. So let’s talk about how this all works, starting with the audit itself. An IRS audit is just a review, a verification. It doesn't mean your client did anything wrong. But how do they even get picked? Sometimes it's a computer model called the Discriminant Inventory Function System, or DIF. It's basically an algorithm that scores returns and flags ones that look like they might have errors. Think of it like a credit card company’s fraud alert—it just sees a pattern that’s a little unusual and wants a closer look. A much more common way is through simple information matching. The IRS computers see a W-2 from an employer and a 1099 from a client, and they compare those numbers to what you put on the return. If they don't match up, a notice gets generated automatically. Easy. Or, it could be a domino effect. Say the IRS is auditing a partnership your client is in. That can trigger an audit for your client, too. It's called a related examination. Now, not all audits are created equal. They come in a few flavors. The least scary is a correspondence audit. It's all done by mail. They just want you to send in proof for a few specific things, like charitable donations or something. A step up from that is an office audit. This is where you actually have to gather your records and go to an IRS office to meet with someone. And then there's the big one: the field audit. That’s when an IRS agent comes to your client’s place of business to do a much more comprehensive review. Okay, so let's say the audit happens, and the agent disagrees with something. They propose a change. What happens next is a critical sequence of events. First, you'll get a report and something called a 30-day letter. This letter is basically an invitation to keep talking. You can agree, or you can appeal internally to the IRS Office of Appeals. You have options. But if you can't reach an agreement, the IRS sends the 90-day letter. And this one is different. You need to understand this for the exam and for life. The 90-day letter is formally called the Statutory Notice of Deficiency. Think of it as a non-negotiable, one-way ticket to a specific destination: the U.S. Tax Court. Once that letter is mailed, a 90-day clock starts ticking. Your client has exactly 90 days to file a petition with the Tax Court. If you miss that deadline, the game changes completely. The IRS can assess the tax and start collections. Your only option then is to pay the bill first, and then sue for a refund in a different court. That 90-day letter is the gateway. This brings us to the core of today's talk: the clock itself. The IRS doesn't have forever to come after you for more tax. There's a statute of limitations. It’s like a shot clock in basketball. Once it expires for a given tax year, the game is over. The most important rule to get right is figuring out when that shot clock starts. The clock starts on the LATER of two dates: the date the tax return was actually filed, or the original due date of the return. So if an individual files their return on March 1st, but it was due April 15th, the clock starts on April 15th. The IRS always gets its full window of time. Filing early doesn't shorten it. So, how long is that window? The general, default rule is three years. For a normal return without any huge problems, the IRS has three years from that start date to assess more tax. But... that clock can get extended. If a taxpayer has a substantial understatement of gross income, the statute extends to six years. What's "substantial"? The rule is very specific: it’s when you omit gross income that is more than 25% of the gross income you *stated on the return*. That last part is key. You test the omission against what was actually reported. And then there are two situations where the clock never runs out at all. It's indefinite. The first is if the IRS can prove fraud or a willful attempt to evade tax. The second is much simpler: if you never file a return in the first place. If you don't file, the shot clock never starts. The IRS can assess tax on you forever. Let's walk through a classic exam-style question. Kai, an individual, filed his 2022 tax return on April 1, 2023. The due date was April 15, 2023. He reported $80,000 of gross income on the return, but he completely forgot to include $50,000 of freelance income. The question is: when does the statute of limitations for the IRS to assess tax expire? Okay, let’s break it down. Step one: when does the clock start? It's the LATER of the filing date, April 1, 2023, or the due date, April 15, 2023. So, the clock starts on April 15, 2023. Step two: Do we use the normal 3-year rule, or does an exception apply? We have to check for that substantial understatement. The amount he omitted was $50,000. Is that more than 25% of the gross income *stated on the return*? The income on the return was $80,000. So, we calculate 25% of $80,000, which is $20,000. Since the $50,000 omission is way bigger than the $20,000 threshold, the 6-year statute of limitations applies. Not the 3-year one. Step three: Calculate the expiration date. We just add six years to our start date. April 15, 2023, plus six years, gives us April 15, 2029. That's the answer. The IRS has until April 2029 to go after Kai for that mistake. If you picked 2026, you fell for the trap of just applying the 3-year rule without checking the numbers first. Now, that's the clock for the IRS. But there's also a clock for the taxpayer who wants to claim a refund. The rules are different here. You have to file a claim for a refund within the LATER of two periods: three years from the date you filed the return, or two years from the date you paid the tax. That second part—two years from payment—is really important. Let’s say you get audited for your 2022 return and you end up paying an extra five grand on June 1, 2025. Then, a year later, you realize you missed a huge deduction on that same 2022 return. Your original 3-year window might be closed, but you still have until June 1, 2027—two years from when you paid that extra tax—to file your refund claim. And here’s a major pitfall. Those special rules that extend the IRS’s clock—the 6-year rule for big omissions and the indefinite rule for fraud—they ONLY work in the IRS's favor. They do not give a taxpayer extra time to claim a refund. The refund clock is what it is. Period. A good way to keep the assessment statutes straight in your head is the "3-6-Infinity" rule. Three years is the standard time limit. Six years is for sizable mistakes, that greater-than-25% understatement. And infinity is for serious problems, like fraud or failing to file at all. Standard, Sizable, Serious. 3, 6, Infinity. Of course, beyond statutes of limitation, there are penalties. For the taxpayer, the big ones are failure-to-file and failure-to-pay. The failure-to-file penalty is harsher, at 5% per month, versus half a percent for failure-to-pay. They both cap out at 25%. There’s also a 20% accuracy-related penalty for things like negligence. And we as preparers have our own standards to live up to. You'll hear terms like "reasonable basis," "substantial authority," and "more likely than not." These are just different levels of confidence in a tax position. Reasonable basis is the lowest bar, maybe a 20% chance of winning. You need at least that to take a position, and if it's not stronger, you probably need to disclose it. Substantial authority is a higher standard, around a 40% chance of success, and it can help a taxpayer avoid penalties even without disclosure. The highest standard is "more likely than not," which is over 50%. You need that for riskier things, like tax shelters. On exam day, when you see one of these statute of limitations questions, the first thing you should do is find the three key dates and jot them down: the original due date, the actual filing date, and any date the tax was paid. The question is almost always trying to trick you into picking the wrong start date for that 3- or 6-year clock. Just a quick self-test before we wrap. One: A corporation filed its 2022 tax return on February 1, 2023. The due date was March 15, 2023. When does the normal 3-year statute for assessment expire? And two: An individual reported $100,000 of gross income. The IRS finds they omitted another $30,000. What's the statute of limitations for the IRS here? Think on those. The world of IRS procedures can feel complicated, but it's really just a set of timelines and rules. If you can master them, you're not just ready for the exam—you're ready for that panicked client call. Remember the 90-day letter is your ticket to Tax Court, the IRS clock is generally 3 years but can stretch to 6 or infinity, and your refund clock is totally separate. Learning these rules is one thing, but getting them into your long-term memory takes practice. VoraPrep is a full exam-prep app — lessons, practice questions, and an AI tutor in one place. You can find everything you need to pass at Vora Prep dot com. It's free to get started. Alright, that's all for today. Keep up the great work. You've got this. I'll talk to you on the next one.