Statute of Limitations Question

[JohnH]

I'm going over a situation with a potential client and I have a question. The taxpayer is sole shareholder in a C-corp which failed to file its 2001 and 2003 tax returns. The personal returns were filed on time each year.

I discovered payments from the corp in 2001 and 2003 to the shareholder and on his behalf which should have been handled as constructive dividends. Total for each year is about $10K. The corp will not deduct them of course, but what happens at the personal level? Can IRS assess the taxpayer for 2001 and 2003 even though those years are closed?

This is probably a simple matter for some of you, but for some reason it just has me stumped.

[erchess]

I thought

that the only ways the IRS could open a closed year were to claim that no return was filed or to claim that there was fraud in the closed year or that they were looking for fraud on a particular issue because they had found it in an open year and were just going back.

The practical advice I have always been given is that few taxpayers are going to hire a lawyer to fight in court over whether allegations if true rise to the level of fraud and that therefore the service can in effect go back as far as it darn well wants to.

Because of that, my thought is that the unfiled corporate returns should be filed and the corresponding individual returns should be amended and the large sum of money involved for tax, interest, and penalty should be paid before it gets any larger. Depending on why the corporate returns were unfiled perhaps there can be abatement of some of the penalty. It is hard for me to imagine someone so wealthy that he could examine his return carefully without noticing that 10K had not been reported.

[OtisMozzetti]

Substantial understatement of tax

the only ways the IRS could open a closed year were to claim that no return was filed or to claim that there was fraud in the closed year or that they were looking for fraud on a particular issue because they had found it in an open year and were just going back.
...

Even with around $10K unreported, this may or may not be "substantial understatement of tax", but that would be a reason for the statute of limitations period to be a longer time. (6 years from the due date of the individual's return if I'm not mistaken)

[JohnH]

I've been trying to bone up on the issue, but just havent' had time to thoroughly research it. I will do so in the coming days/weeks. I seem to recall that the bar is quite a bit higher for reopening a closed year, and I'm interested in hearing how many on this forum have handled situaitons in which a closed year was reopened. I believe the "substantial understatement" issue concerns assessment of a penalty rather than a reason to open closed years, but maybe the two just go hand in hand.