It is not often in life that one is able to hit pause, rewind, and redo something that has already happened. To many taxpayers’ surprise, however, taxes are just one such area. Knowing the various options for correcting an error on a tax filing can help mitigate the many consequences of an erroneous tax return, including the elimination of penalties.
The Ordinary Amended Tax Return
It is common knowledge that a taxpayer can file an amended return to correct items on a previously filed return. While there is no statutory authority for amending a return, it is widely accepted and recognized by the IRS. Such a filing takes the form of a new return that generates a corrective entry in the IRS’s records reflecting the change or changes made. For example, if a taxpayer files an individual income tax return reporting a tax liability of $20,000 and thereafter files a return reflecting a tax liability of $25,000, the amended return generates a corrective entry of $5,000 in additional tax due. The original return remains on the IRS’s records and will continue to be treated as the taxpayer’s original return. Generally, a taxpayer has three years from the original filing date to file an amended tax return reporting any changes in income.
The Superseding Tax Return
In certain situations, a taxpayer can effectively undo the filing of the original return and file a revised, or superseding, return. When a superseding tax return is filed, it is as if the original return were never filed. Thus, in the example above, a superseding return would establish a single $25,000 tax due entry on the taxpayer’s account. The ability to file a superseding tax return is limited, but where available it is often the best way to correct a previously filed return.
A taxpayer can file a superseding tax return at any time after filing an original return and before the due date for filing such a return has passed. Thus, a taxpayer whose return is due on April 17, 2017, but who decides to file on February 10, 2017, can file a superseding return anytime between February 10 and April 17, making any necessary adjustments. The superseding return will be treated as the taxpayer’s original return for all purposes. Thus, if the original return underreported the taxpayer’s tax liability, the superseding return can correct that underreporting while avoiding the accuracy-related penalty normally imposed. This is so even if the taxpayer does not have reasonable cause for the omission, as the superseding return effectively removes the omission from the record. Despite seeming too good to be true, there are logical reasons for this result. By filing a correct superseding return before the due date, the taxpayer has complied with the law and has provided the IRS with the information it needs by the due date. Since the taxpayer was under no obligation to file his return prior to the due date, the IRS is not disadvantaged in any way.
For the purposes of a superseding return, the due date includes any valid extension. Therefore, a taxpayer who files a valid extension but ultimately files the return sometime before the expiration of the extended filing date will have until that extended due date to file a superseding return.
The benefits of filing a superseding return go far beyond the ability to correct errors without risk of an accuracy-related tax penalty. Because a superseding return is treated as the taxpayer’s “first return,” it can be utilized to make or change binding elections that would otherwise not be open to revision. This is perhaps even more valuable than avoiding penalties, especially for corporate and business filers, where a single missed election can have devastating consequences that affect future tax years. In fact, court cases and IRS rulings have held that a superseding return even allows for the revocation of an election that is otherwise irrevocable.
Superseding returns have other time-altering powers. If a taxpayer is required to file an information return but fails to do so, a superseding return can be used to rectify the error. For example, taxpayers with a requisite interest in a controlled foreign corporation are required to attach IRS Form 5471 to their income tax return. If a taxpayer fails to file Form 5471, she is subject to a $10,000 late filing penalty, even if the failure was not intentional. To avoid the penalty, she would have to incur the expense (and heartache) of trying to demonstrate to the IRS that the failure was due to reasonable cause, often a difficult standard to satisfy. If, however, the taxpayer catches the omission of Form 5471 after filing her original return but before the due date has passed, she can file a superseding return and attach the required Form 5471—making it timely filed.
To make the most of superseding returns, CPAs should consider filing extensions even for taxpayers who will ultimately file their returns on the original due date. By doing this, such taxpayers will have extra time to catch mistakes and correct them without negative consequences. While it is likely impractical for CPAs to do this for all of their clients who file their returns by the original due date, it is likely a good strategy for some of them. For example, an individual taxpayer who is eager to file by April 15 because he is expecting a refund may want to file an extension to October 15, which may allow him to correct any errors made on the original return by use of a superseding return. Similarly, filing an extension may be good practice for a partnership that files Form 1065 and issues K-1s by the original due date. Such a partnership may itself receive amended K-1s from higher-level partnerships after making its original filings, and such revisions may then subject it to filing obligations that it had not previously foreseen. For example, the partnership may need to file Form 8886 to disclose a reportable transaction. The failure to do so could subject the lower level partnership to a $10,000 penalty, but if the partnership is able to file a superseding tax return, it can avoid that penalty.
The Qualified Amended Return
As for taxpayers who miss the window for filing a superseding return, all hope is not lost. Such a taxpayer can still mitigate the accuracy-related penalties for an understatement of tax by filing a qualified amended return. Generally, a qualified amended return is filed after the due date for the original return has passed but before the IRS has taken certain actions that either put the taxpayer on notice of a possible understatement or otherwise indicate that the IRS is already on the path to finding the understatement on its own. Thus, a qualified amended return must be filed before any of the following has occurred:
- IRS contact with the taxpayer regarding a civil or criminal examination of the tax return at issue;
- IRS contact with any person regarding a tax shelter examination under IRC section 6700 for a tax shelter in which the taxpayer has participated;
- In the case of a pass-through item, IRS contact with a passthrough entity regarding the item at issue;
- IRS service of a summons relating to the tax liability of a person, group, or class that includes the taxpayer (or passthrough entity) with respect to an activity for which the taxpayer claimed any tax benefit; or
- IRS announcement of a settlement or compromise initiative with respect to a listed transaction that the taxpayer participated in that year (further restrictions apply in the case of an undisclosed listed transaction).
When a taxpayer properly files a qualified amended return, the IRS will not assert the accuracy penalty with respect to any additional liability. If the taxpayer’s understatement on the original return is due to fraud, however, the taxpayer will not avoid penalties by filing a qualified amended return.
The different paths to compliance after the filing of an imperfect tax return highlight the need for careful consideration by taxpayers and their advisors of how one goes about correcting past errors. These options also require that taxpayers and CPAs consider filing extensions even in cases where it is perhaps counterintuitive to do so. Finally, taxpayers who cannot correct their past mistakes by one of the methods described here—such as taxpayers whose omissions were fraudulent or spanned many years—should consider other paths to compliance, including a corrective filing pursuant to the IRS’s voluntary disclosure policy.