Self Directed IRAs, Prohibited Transactions, and the IRS Statute of Limitations: Thiessen v. Commissioner
In the recent case of Thiessen v. Commissioner, 146 T.C. No. 7 (2016), the Tax Court considered how long the IRS has to allege a prohibited transaction against self directed IRAs. In general, the IRS must allege a prohibited transaction against self directed IRAs within three years after the return is filed. IRC 6501(a). However, that time-period may be extended another three years for a total of six years pursuant to IRC 6501(e)(1) when the taxpayer fails to report an amount that is in excess of 25% of the gross income stated in the return.
For prohibited transaction rule violations, a failure to report occurs when you don’t disclose the prohibited transaction to the IRS or when you fail to claim the distribution that occurs from a prohibited transaction on your personal tax return. A prohibited transaction could be disclosed to the IRS through attachments to the return or other correspondence but the Tax Court first looks to see what was reported to the IRS on the IRA owner’s personal 1040 tax return for the years in question. In other words, if you don’t volunteer clear information of a prohibited transaction to the IRS then the limitation period can be extended up to a total of six years so long as the prohibited transaction would result in a gross income in excess of 25% of the taxpayer’s personal return. Note: IRS Form 5329 is used to declare a prohibited transaction on your personal return.
There are a few very important takeaways from the Tax Court’s ruling in Thiessen and from the IRS Internal Revenue Manual on Prohibited Transactions.
STATUTE OF LIMITATION TIPS
|PRACTICAL THREE YEAR PERIOD||According to the IRS Agent Manual, Internal Revenue Manual, 18.104.22.168, IRS agents are instructed and trained to only review for prohibited transactions within self directed IRAs within a three-year window. In order to pursue a prohibited transaction past three years, an agent must receive approval from IRS Area Counsel. So, for practical purposes, the IRS is examining prohibited transactions within a three-year window.|
|FAILURE TO DISCLOSE SIX YEAR PERIOD||
As had occurred in Thiessen, if any IRA owner fails to disclose a prohibited transaction to the IRS, the IRS may pursue a prohibited transaction for up to six years. This six-year clock runs six years after you filed your return in question. So, if you filed a 2010 personal return on April 15, 2011, and if the return did not include disclosure of a prohibited transaction, the IRS could pursue a prohibited transaction up until April 15, 2017. Keep in mind, this failure to report though must be a prohibited transaction that exceeds 25% of the gross income of the taxpayer for the year in question.
A final word to note is that the IRS may pursue prohibited transactions past six years and into an indefinite time-period when the prohibited transaction was fraudulent or a willful attempt to evade tax. IRC 6501(c)(1),(2),(3). I’m not aware of cases in this situation, nevertheless, don’t expect to be in safe waters if you fraudulently entered into a prohibited transaction as the statute of limitations never runs in those situations.