Waive or Walk: Considerations forExtending the Statute of Limitations

Jeffrey A. Friedman and Michael L. Colavito Jr.

Jeffrey A. Friedman Michael L. Colavito Jr.

Intuitively, most taxpayers likely assume thatgiving a tax authority more time to examine theirtax return is a bad idea. After all, an extension of thestatute of limitations provides state auditors withmore time to audit and likely refine an assessment.However, there are times when agreeing (or request-ing) an extension of the statute of limitations isjustifiable or necessary. This installment of A Pinchof SALT explores the issues that arise when ataxpayer is considering whether to agree to, orrequest, an extension of the limitation on assess-ments during a state audit. We further suggest someideas that can make the decision easier, such ashaving a corporate policy on signing waivers.

Waivers at the Federal Level

The federal rules for extending the statute oflimitations forms the basis for many states’ rules, soa brief discussion of the federal rules is helpful toprovide a basis for reviewing some state variances. Ataxpayer and the IRS, before the expiration of thestatute of limitations prescribed for the assessmentof any tax (excluding estate tax), can agree inwriting to an extension of the assessment limita-

tion.1 Although a taxpayer can agree to an uncondi-tional consent, allowing the IRS to examine anyissues on the return,2 the IRS is required to notifythe taxpayer of the taxpayer’s right to refuse toextend the period of limitations, or to limit theextension to a certain period of time or to particularissues.3 At the federal level, an agreement to extendthe period for assessment also extends the periodduring which the taxpayer may claim a refund orcredit to six months after the agreed time of exten-sion of the assessment period.4 The main purpose ofallowing an extension of the assessment period is toavoid interruption of the established process of taxreturn examination by the imminent expiration ofthe statutory period of limitations for assessment.5The IRS likely will take immediate steps to allow itto assess any tax if a taxpayer refuses to sign aconsent, which means that a notice of deficiency willlikely follow shortly after any such refusal to agreeto a waiver.6

The Internal Revenue Code does not restrict thelength of an extension or the extent of the continuedexamination; therefore, the parties have the flexibil-ity to negotiate the tax issues covered by the consentas well as the length of the extension period. Forms872 and 872-A are the forms typically used toeffectuate an extension of the statute of limitations.Form 872 is used for extensions that typically arereferred to as ‘‘fixed-date’’ consents, which extendthe assessment period to an agreed-on date, themost common type of extension. Form 872-A allowsfor an ‘‘open-ended’’ extension, which is for exten-sions that do not expire on a certain date. Anopen-ended extension period generally remains open

1IRC section 6501(c)(4)(A).2See Internal Revenue Service Publication 1035 (June

2007).3IRC section 6501(c)(4)(B).4Treas. Reg. section 601.105(f).5Id.6Supra note 2.

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until 90 days after the IRS or the taxpayer sends theappropriate notice ending the extension agreement.7

Typical State Waiver Provisions andTheir Differences

Most state rules for extending the period of as-sessments are based, in part, on the federal rules.For example, New Jersey provides that:

If, before the expiration of the period pre-scribed herein for the assessment of additionaltax, a taxpayer consents in writing that suchperiod may be extended, the amount of suchadditional tax due may be determined at anytime within such extended period. The periodso extended may be further extended by sub-sequent consent in writing made before theexpiration of the extended period. The consentof a taxpayer to extend the period of assess-ment shall extend the period in which thetaxpayer may file a refund claim with respectto the identical taxes and tax periods for whichthe limitations periods have been expresslyextended by written consent of the taxpayer.8

Notably, the provisions of New Jersey and manyother states that pertain to waivers provide for anautomatic extension of time to file an application forcredit or refund whenever an extension of the as-sessment limitation is executed.9 That is not alwaysthe case. For instance, Georgia law provides thatwhen an extension agreement is entered into be-tween the commissioner and a taxpayer the commis-sioner ‘‘is authorized . . . to extend similarly the pe-riod within which a claim for refund may be filed,’’10

which suggests that such an extension to the periodfor claiming a refund is not automatic. Georgia’sseparate treatment of extensions for assessmentsand refunds creates a trap for the unwary. Notaxpayer should agree to extend the statute of limi-tations unless the extension allows the taxpayeradditional time to identify and claim refunds.

When a particular state provision does provide forthe automatic extension of time to file a claim forrefund whenever a waiver is signed, taxpayers mustpay close attention to the length of that automaticextension. Similar to the federal provision, manystate provisions regarding extending the assess-ment period extend the time for filing a refund claimto a period ending some time after the extended

assessment period ends (for example, six months).11

That is not the case in all states. For instance, inIowa and Oklahoma an agreement extending theperiod for assessment automatically extends theperiod for a refund claim, but only to the same dateof the assessment extension period.12 Therefore, ifan assessment is issued close to the end of theextended period, rather than having additional timeto file a claim a refund, a taxpayer will have to actquickly, since the time to file such a claim is thesame as the extended assessment period.

No taxpayer should agree toextend the statute of limitationsunless the extension allows thetaxpayer additional time to identifyand claim refunds.

Unlike the federal rule, which requires the IRS tonotify taxpayers of their right to limit the issues,many state provisions are silent as to such a right.For example, California specifically recognizes thetaxpayer’s right (and the Franchise Tax Board’sobligation to notify the taxpayer of that right) tolimit an extension to a particular period of time, butdoes not address limiting a waiver to specific is-sues.13 Despite the right not being specifically statedand similar to the flexibility at the federal level innegotiating waiver agreements, taxpayers that arerequested to sign a state waiver typically do havethe ability to limit the issues to which the extendedperiod will apply. As discussed more fully below,such narrowing of the continued examination is oneof many practical considerations that a taxpayershould consider when requested to sign a waiver.

When to Walk and When to Waive: PracticalConsiderations

Whether to agree to or to request a waiver of thestatute of limitations requires the consideration ofseveral important issues. First and foremost, thedecision to extend is dependent on the individualfacts and circumstances, and taxpayers should givecareful consideration before consenting to or re-questing a waiver. Those facts and circumstancesinclude: the relationship with the auditor and auditteam; the circumstances surrounding the reason forthe extension request (for example; delays because

7Id.8N.J. Admin. Code section 18:2-2.6(b).9See, e.g., N.Y. Tax Law section 1147(c); Del. Code Ann. 30

section 539(c)(1); Ark. Code Ann. section 26-18-306(d).10Ga. Code Ann. section 48-2-49(d) (emphasis added).

11NYCRR 8-2.2; Ark. Code Ann. section 26-18-306(d). NewYork allows for an additional six months to file a claim forrefund, while in Arkansas a taxpayer is given an additional60 days.

12Iowa Admin. Code 701-51.2 (422)(3); Okla. Stat. section223(B).

13Calif. Revenue and Taxation Code section 19067(b).

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of auditors’ actions or the taxpayer’s actions); thepotential tax liability; and the likelihood of an as-sessment (that may be based on estimate) if a waiveris refused.

Requesting a WaiverThe benefits of an extension of the statute of

limitations are not always a one-way street. Theadditional time might also be beneficial to tax-payers. Numerous reasons arise for not fully re-sponding to a state’s information document request,including overly broad and overly extensive re-quests, the tax department’s limited resources, andinadequate time provided to a tax department torespond to the request. An extension allows taxpay-ers additional time to produce documentation thatmay support its positions on the return. Further,agreeing to a reasonable waiver could go a long waytoward maintaining an amiable relationship with anauditor who may be back to audit later periods. Mostimportantly, some states limit the ability of taxpay-ers to introduce information on appeal (or in litiga-tion) that was not provided during the course of anaudit.14 If a taxpayer has information that supportsits position, a waiver may be needed to ensure thatthe record is fully developed.

Time Period of the ExtensionRegarding the period of the extension, a taxpayer

should discuss with the examiner the reasons for therequested extension and grant only the minimalamount of time needed to complete that examina-tion. However, the extension should not be unreal-istic because an overly short extension will leadinevitably to yet another extension.

Issues Included in the ExtensionLimiting a requested extension to particular is-

sues can be an effective tactic and compromise inconsenting to additional time to allow a state toaudit. Issue limitation will allow the statute oflimitations to close all noncovered issues exceptthose specified in the waiver agreement. In specify-ing the covered issues, it is important to take intoaccount the interaction of various issues. For in-stance, an agreement to keep the statute of limita-tions open to allow a state additional time to audit anonbusiness income position will have consequenceson the taxpayer’s apportionment formula calcula-tion and possibly on the use of net operating losses.Consideration of those cascading consequences isimportant in defining the scope of the issue forpurposes of the waiver.

Interest and Penalty ConsiderationsAn evaluation of interest imposed on underpay-

ments and overpayments should be taken into ac-count in determining whether a waiver is justified.For instance, some states pay substantial amountsof interest on overpayments and therefore a tax-payer that believes it is due a refund may be in nohurry to expedite an audit because the interestearned on the overpayment may be higher thanother available investment options.15 However, highinterest rates imposed on underpayments may mili-tate toward a short waiver period, or perhaps noneat all.

Although this is not very common, there may bean opportunity to toll the running of interest duringthe extension period. For example, Hawaii allows allinterest on underpayments to be tolled during theassessment period if the taxpayer submits a cashbond deposit.16

Rejecting a request for a waivercould give an auditor an incentiveto more aggressively assesspenalties.

The prospect of suffering the imposition of penal-ties also affects a taxpayer’s stance on waivers.Many tax penalties are subjectively imposed, andrejecting a request for a waiver could give an auditoran incentive to more aggressively assess penalties.Also, some states’ amnesty programs provide for theabatement of penalties, but failure to participate inthe program can lead to mandatory penalty assess-ment. A waiver could extend an audit beyond thetime period of an amnesty program, thus making thebenefits of the program unreachable.

Corporate Waiver PolicyTo maintain consistency and predictability for tax

department personnel and state tax auditors, it isfundamental for a business to have a corporatepolicy that describes the situations under which thetaxpayer will consider consenting to or requesting awaiver. Although some taxpayers have corporatepolicies to not grant waivers unless there is someunique circumstance, most taxpayers have well-defined policies that describe: the conditions underwhich a waiver will be granted; a time range for theextension; a requirement that the waiver apply toassessments and refunds; and an expectation thatthe waiver be limited to given issues.

14See, e.g., United Parcel Service Co. v. Director, Div. ofTaxation, 25 N.J. Tax 1, 45 (N.J. Tax 2009) (holding that‘‘[p]laintiffs may not rely on information withheld during theaudit process, and not produced until shortly before or attrial, as a basis for challenging the Director’s [] analysis.’’).

15Wis. Stat. section 71.82(1)(b).16Hawaii’s interest rate on underpayments is 8 percent

annually. Hawaii Tax Information Release 2008-03, Dec. 15,2008. It should be noted, however, that a cash bond may alsocreate an additional audit expense.

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In addition to documenting the policy, it is impor-tant to communicate it to tax department personneland to auditors at the commencement of an audit.Failure to communicate the policy will undermineits utility and suggest to a state auditor that thepolicy is not uniformly followed.

Simply Refusing Does Not Warrant aJeopardy Assessment

As discussed, taxpayers are under no obligation toconsent to a waiver of the statute of limitations.However, states often raise the possibility of a jeop-ardy assessment if a taxpayer does not consent. Ajeopardy assessment, which is often based on anestimate or extrapolation, can yield an unrealisti-cally large assessment that puts the taxpayer at adisadvantage in negotiating a resolution to the auditand also may have detrimental financial statementeffects. In fact, the threat of a jeopardy assessmentis the most common rationale for agreeing to awaiver. Some taxpayers have been conditioned tobelieve that the serial granting of waivers is neces-sary to avoid a jeopardy assessment. Other tax-payers are asserting taxpayer bill of rights to avoidthis type of leverage. And some taxpayers havesuccessfully challenged state attempts to issue jeop-ardy assessments when the taxpayer has fully coop-erated during the course of the audit.17

State Extension Because of a Federal WaiverAs discussed, the IRS and a taxpayer can enter

into a waiver agreement generally by signing aForm 872 or 872-A. That federal extension can affecta state’s statute of limitations as well. Even if nofederal waiver is signed and a taxpayer reports afederal change to a state by filing an amended statereturn for a tax year that is otherwise closed, thestate statute is reopened to allow the state time todetermine if it agrees with the taxpayer’s reportingof the federal adjustment.18

State law typically provides for an automaticextension of the statute of limitations on a federal

waiver being signed. Uncertainty arises as to what,if any, limitations there are to the automatic stateextension. That is well illustrated by the relevantCalifornia statute, which provides for an extensionof ‘‘six months after the date of the expiration of theagreed period for assessing deficiencies in the fed-eral income tax.’’19 The statute is silent as to anylimitations to the extension, leaving the implicationthat the state could issue a notice of deficiencyduring the extending period on any issue, regardlessof whether the federal extension has been limited tospecific issues. Delaware’s statute is also unclear,but seems to imply that any issue limitation at thefederal level would also apply to the state, by pro-viding that any agreement with the IRS shall con-stitute an agreement with Delaware to extend thelimitation period.20 That seems to suggest that theterms of the agreement at the federal level will bethe same at the state level. New Jersey and Arizona,however, specifically limit the extension to itemsarising out of those provided for in the federalwaiver.21 Colorado takes an interesting approach byallowing any deficiency assessments by the stateduring the automatic extension period to be limitedto those arising out of items adjusted at the federallevel only if the taxpayer’s state return has beenaudited and settlement has been made regardingthe return.22

Making matters more complicated, some stateswill reopen the state statute of limitations based ona federal revenue agent’s report. In fact, some stateswill reopen an otherwise closed statute of limita-tions for all issues, whether related to the RAR ornot.23 Taxpayers should consider the filing of afederal waiver or an anticipated federal RAR inconsidering whether to agree to a state waiver.Failure to do so could result in unnecessarily debat-ing or offending a state auditor over the proprietyand length of a state waiver when the statute couldbe extended or reopened regardless of a state agree-ment.

Unitary WaivingIn the case of a unitary combined group return,

an issue arises about the effect of a waiver thatrelates to only one or some members of the group.There is not much guidance on this issue and theavailable authority is inconsistent and often incom-plete. For example, even though each taxable mem-ber of a Massachusetts combined return computes

17See, e.g., Alexandre v. Law, CV 07 4015060S, WL 941976(Conn. Super. Mar. 17, 2009). The taxpayer in Alexandre wasissued a jeopardy assessment after refusing to sign an exten-sion of the statute of limitations. There was no evidence tosuggest that the taxpayer would obstruct the collection proc-ess, leave the jurisdiction, or remove property from thejurisdiction. The court, in concluding that the jeopardy as-sessment was invalid, held that, despite the statute granting‘‘broad authority to issue a jeopardy assessment by the words‘if the commissioner believes,’ this belief is tied into thequestion of whether there is a ‘reasonable belief’ that thetaxpayer’s actions will impair the collection of tax.’’ Id. at *7.(For the decision, see Doc 2009-7377 or 2009 STT 62-14.)

18For example, Indiana law provides the Department ofRevenue six months from the date the taxpayer notifies it ofthe federal change to issue a proposed assessment. Ind. Codesection 6-8.1-5-2(g).

19Calif. Revenue and Taxation Code section 19065.20Del. Code. Ann. section 531(f).21N.J. Rev. Stat. section 54:10A-13; Ariz. Rev. Stat. Ann.

section 42-1104(8).22Colo. Rev. Stat. section 39-22-601(6)(g) (emphasis added)23See, e.g., Okla. Stat. section 2375(H)(4); R.I. Gen. Laws

section 44-11-19(b).

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its excise tax liability separately,24 each member isjointly and severally liable for the tax due from anymember, and any assessment issued for one entity isdeemed an assessment against all members of thecombined group.25 Further, each member’s appor-tionable income is based on the taxable income ofthe entire combined group,26 thus any item adjustedfor one entity will cause a change in income to allmembers of the group. With that said, it still seemsunclear how an extension for one entity would affectthe others — all the more reason to have the waiveragreement drafted in a way to specifically addressthis issue.

Further, in West Virginia the statute of limita-tions open for a particular member of a combinedgroup remains open for that member, even if thestatute of limitations has expired for one or moreother members of the combined group.27 Althoughthat policy does not address the specific situation ofhow the group would be treated if one member of acombined group has granted a waiver, it does indi-cate that, for statute of limitations purposes, thegroup is not treated as one taxpayer, but rather asindividual taxpayers. Thus, in West Virginia awaiver might have to be executed for each memberof the group.

Conversely, a ruling in Illinois held that a waiverapplied to an entire unitary group, despite themembers in question having filed as separate tax-payers for the applicable years because the Depart-ment of Revenue found the members should havefiled as a unitary group.28 The implication is thatmembers of a unitary group will be treated as onetaxpayer for purposes of waivers.

Other states specifically address the effect that awaiver for one entity has on the rest of the combinedgroup. California provides, by regulation, that forunitary combined groups electing to file a groupreturn ‘‘waivers to extend the statute of limitationsfor issuing Notices of Proposed Assessments must beexecuted by the key corporation and are effective forall taxpayer members.’’29 In light of the inconsis-tency and lack of clarity pertaining to waivers in thecontext of combined returns, a taxpayer in theprocess of negotiating an extension should attemptto determine if there is a rule on point in the stateand, if limiting the extension to some taxpayers ispossible, should consider whether doing so is advan-tageous.

ConclusionDeciding whether to sign, or request, an exten-

sion of the statute of limitations involves both prac-tical and legal considerations that, if not carefullyexamined, can cause unforeseen results. A carefullyconsidered corporate policy regarding state statu-tory waivers that is clearly communicated to stateauditors can mitigate tension over waiver requests.In forming that policy, taxpayers should take intoaccount the importance of state auditor relations,the risk tolerance associated with jeopardy assess-ments, interest rates on under- and overpayments,penalties and amnesty programs, and the status offederal audits. Serial state waivers should beavoided when possible because they create the ex-pectation for future waivers and increase the likeli-hood of old, lingering audits. ✰

24Mass. Gen. L. section 32B(d)(4).25Id. at section 32B(e); Mass. Regs. Code section

63.32B.2(11)(b).26Mass. Gen. L. section 32B(d)(3).27W.Va. Code of State Rules section 110-24-13a.3.d.28Illinois Dept. of Rev. v. ABC Telecom Corp., No. IT 00-8

(DOR Hearings, Aug. 27, 2000).

29Calif. Code Regs. section 25106.5-11(d)(5).

Jeffrey A. Friedman is a partner and Michael L. ColavitoJr. is an associate with Sutherland Asbill & Brennan LLP’sState and Local Tax Practice.

Sutherland’s SALT Practice is composed of 20 attorneyswho focus on planning and controversy associated withincome, franchise, sales and use, and property tax matters,as well as unclaimed property matters. Sutherland’s SALTPractice also monitors and comments on state tax legislativeand policy efforts.

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