We are often asked if an error on a prior-year tax return can be corrected if it results in an increased tax in the current year. The answer is “maybe.” There are two issues that have to be considered, namely, whether (1) there is still time to correct the prior year’s tax return and, if not, (2) whether the IRS could challenge the position using the duty of consistency rule.
Correcting the Prior Year’s Tax Return
A tax return can typically be corrected if the change is made within three years from the date the tax return is filed. If the tax reported on the tax return was not paid, the return may be changed at any time within two years from the date the tax was paid. This is set out in Section 6511 of the Code.
These corrections are made by filing amended returns.
Most items can be corrected in this manner, but there are exceptions. Some items cannot be corrected without first obtaining the IRS’s consent. When these rules apply, there is typically a regulation or administrative guidance saying that the IRS’s consent is required. The guidance will also typically say how to obtain consent. This may have to be done by obtaining a private letter ruling from the IRS or, in other cases, by simply making an administrative request.
If the tax return can be amended by filing an amended tax return, it may be possible to correct the prior year’s return and then file the current year’s return. This can allow the current year’s tax return to report the position that results in lower tax in the current year.
The Duty of Consistency Rule
If the prior year’s tax return cannot be changed, the duty of consistency rule must be considered. This rule is intended to ensure that taxpayers do not benefit from the prior mistreatment of an item on a tax return.
The duty of consistency rule generally says that a taxpayer may not take a factual position on a tax return in a previous tax year and a contrary position in a later tax year after the time has passed for correcting the prior tax year.
The duty of consistency is a defense that can be raised as a defense by the IRS.
For the defense to be successful, the IRS has to show that there was (1) a knowing representation of fact by the taxpayer, (2) that the IRS relied on the taxpayer’s representation, and (3) the taxpayer attempted to change his position after the time had passed to change the prior tax return.
If the IRS can prove these elements, the IRS can treat the initial tax return position as correct even if it was not correct.
We help taxpayers correct prior-year tax returns. If you need to change a position set out in a prior year, we want to hear from you. Call today for a free, no-obligation, consultation.