In what appears to be a continuing bid to tell taxpayers that in the current economic downturn the IRS “feels our pain,” has become a kinder, gentler government agency and tax collector, and even perhaps that the days of being a “no more Mr. Niceguy” government agency have passed into the days of “No more ‘no more Mr. Niceguy,’” IRS Commissioner Doug Shulman recently reminded taxpayers who may be owed a refund for 2005, but have not yet filed their income tax returns for 2005, to claim that refund by filing their return and to do so quickly to avoid losing it.

This may qualify as a continuing effort in light of Commissioner Shulman’s “I feel your pain” comments, published by the IRS in early January, 2009. See Feb 5, 2009 post in this blog, “IRS to Bail Out Taxpayers?” below.

IRS estimates that there is roughly $1.3 billion in unclaimed refunds for tax year 2005 awaiting more than a million taxpayers around the country.

But time is running out for these taxpayers:  Under the rules, a taxpayer has three years from the original due date of the tax return to file his or her return and so be eligible for the refund. After three years, the obligation to file a return remains, but the taxpayer’s right to collect his refund is forfeited. Applying this to tax year 2005, tax returns were due on April 15th, 2006. Three years from April 15th, 2006 is coming up soon, on April 15th, 2009.

So, not only is April 15th this year the due date for 2008 tax returns, but it is the “drop dead date” for claiming a refund for 2005. After that, no refund, Mr. Bond.

Commissioner Shulman said, “Especially in these tough economic times, people should not lose out on the money that is rightfully theirs.” He added, “People should check their records, especially if they had taxes withheld from their paychecks but were not required to file a tax return. They may be leaving money on the table, including valuable tax credits that can mean even more money in their pockets.”

According to IRS estimates, about half the taxpayers who can claim a refund would receive more than $581.  IRS estimates that there are approximately 76,800 taxpayers in New York due refunds at a median higher than the national average median of $581 — $639 — and a total amount of possible refunds of $82,994. New Jersey has 41,100 taxpayers due refunds at a median of $646 and a total of $43,761. Connecticut has 23,700 taxpayers due refunds at a median of $659, and a total of $18,234.

When a taxpayer files a return in time to claim a 2005 refund, that refund might be withheld if they also did not file for 2006 or 2007. The refund might also be used to pay off unpaid child support obligations, or past due federal debts like unpaid student loans or tax debts from other years.

Along with these kinder, gentler public service announcements of the Commissioner, taxpayers should not forget that the primary purpose of the IRS is in fact to collect money through taxes to fund the federal government, and that it has enormous powers beyond those of other, ordinary creditors.

Here we are in the thick of tax season and lots of people are getting their shoeboxes full of reciepts together, organizing their credit card statements and cell phone bills, so that they prepare their tax returns or go to their accountant to do it for them.

Some of us — the enviably well organized — may already be done. Maybe they’ve even prepared their returns already. So now, to file now and get it done? Or to wait until April 15th? Certainly you don’t want to be late (or if you have to be late, you want to file for an extension of time to file), but now the question is: on time or early?

What? No Gold Star? Three Ways Filing Early Might Help

Surprisingly, except three narrow situations, in most circumstances, filing early does you no good. You don’t get extra points or anything.

What you might get, if you are owed a refund, is your refund sooner than if you filed later. That’s one of the three situations: get your refund sooner.

The second situation is where you owe back taxes from prior years and are trying to set up a payment plan or an offer in compromise (that is — settle your whole debt for less than the full amount owed — you’ve soon the excessively rosy ads for this program on late night TV and heard about it on the radio, maybe even seen it in Google Adsense contextual advertising on the internet).

If you are trying to set up a payment plan or get an Offer in Compromise, you need to get your tax return filed to get that most recent tax year (now, 2008) included in the deal. Otherwise, it becomes its own separate obligation, and often that only complicates things.

The third situation is just a peace of mind sort of thing: If it will make you feel better knowing that your tax return is prepared, done, filed — signed, sealed, delivered — as Stevie Wonder might say, and as President Obama borrows from to rouse the crowds, that satisfied sense of completion, having that unpleasant chore done and checked off the To Do list could be another reason to file early.

On Time is as Good as Early, Actually, it May be Better

But under the rules, at least as I’ve read them, other than these three situations, filing early puts you in no better position than if you file on the due date, April 15th.

In fact, in one way, it potentially puts you at a disadvantage.

Here’s how: if you file on time, on the due date (April 15th), or after that, the IRS has three years from the day you file your tax return to assess your taxes. Most of the time this process of assessing happens quickly: the IRS reviews your return, and for most taxpayers, the IRS accepts their returns as accurate and agrees.

For example, you say you owe 3,500 in taxes, you had 3,000 withheld from your paycheck and you enclosed a check for $500 with your return — you say you’re “even” and “paid up” and the IRS agrees. You’re done.

But, for some taxpayers, the IRS either disagrees or isn’t so sure. In those situations, it will initiate an audit (or “examination” as the IRS tends to call it). In an audit, the IRS will recalculate and tell you how much it thinks you owe. Or it will say to the taxpayer, essentially, “we think your tax return is wrong — please provide documents to support x, y, or z deductions.”

The IRS has three years to do this audit process, and then assess what the tax bill is.

Or, more exactly, the IRS has three years if you file your tax return on the due date or later. If you file early, say on March 15th, instead of April 15th, the three year countdown clock for the IRS to audit and asses does not start ticking until the final due date, April 15th.

Do You Want to Give the IRS the Gift of Time?

So, by filing a month early, you give the IRS an extra month to think about your tax return and decide whether to accept it as filed, or to challenge it with an audit. If the IRS uses that extra time to decide to audit you, you have done yourself harm by giving the IRS extra opportunity to audit when it otherwise would not do so.

It is unlikely that it happens often. And, in fact most taxpayers, whether individuals or businesses, don’t get audited. But considering how stressful getting a letter from the IRS saying they intend to audit (the letter will likely say “examine”) your tax return, who wants to increase the chance of that happening?

This is counterintuitive. One would think that nothing could be better than just getting this big chore done and over with. But the three circumstances where filing early does you good are narrow. In all likelihood, you’re better off filing on time rather than early.

A visitor to my website found it by asking this question in a search on Yahoo: “When does the statute of limitations run out for audits?”

The shortest answer is three years.

So the IRS Has Three Years – Three Years Starting When?

But that’s not quite enough information all by itself. The first, next question is: three years from what? What event makes the clock start ticking and counting down?

The shortest answer is that the clock starts counting down, when you, the taxpayer, file your tax return. But that’s not quite the whole story either:

The clock starts ticking upon filing when you file on the due date (like April 15th) or later. But, the clock does not start ticking if you file your return early. For example, if you filed your tax return on March 15th, a month before the day that’s so big on everyone’s mind, April 15th or “Tax Day” as some now call it.

Instead, if you file your tax return early, again, say on March 15th, the IRS will say ‘thank you very much,’ but the statute of limitations clock won’t start ticking until the due date, April 15th.

This is one of those things that puts the rules of taxes into a sort of bizarro-world (many would say one of many!).

The IRS Wants it Bad!

This early filing rule is a little strange because it seems to convlict with the IRS’s desire for taxpayers to file their tax returns. We know that the IRS wants taxpayers to file their tax returns, and, if a bureaucracy could have and express emotions, you could say that the IRS wants this badly. Really wants it. Really wants taxpayers to prepare and file their tax returns.

Yet, however bad the IRS wants it, the tax system’s rule that filing early doesn’t start the clock ticking discourages taxpayers from filing – or at least from filing early, and that seems just a little bit bizarre.

This rule discourages early filing because who wants to give the IRS a free ride? Who wants to give it even more time to decide whether to do things that can make your life difficult? And so, this rule seems to be at odds with the IRS’s strong desire to have taxpayers actually file their returns, though there are a few arguably reasonable reasons for having the rules set up this way.

Still, one would think that the IRS would be inviting and encouraging taxpayers to get their taxes filed, at all, on time, even early, and would add a few carrots to the bundle of sticks it brandishes at those who file late or not at all.

How Do We Know That the IRS Wants It Bad?

Just look at their rules! The IRS charges heavy penalties plus interest for filing late and for not filing at all. By doing this, the government punishes late-filers and non-filers by making it expensive.

And, more than making it expensive, if you ever want to make any kind of arrangement to resolve a tax problem, like if you wanted to set up a payment plan, or an offer-in-compromise or even to be put into “uncollectible status,” the first thing the IRS will insist on is that you get your unfiled tax returns filed.

Like Blofeld, Goldfinger, Largo, and so many other James Bond villains, the IRS says to taxpayers with unfiled returns, “No deals, Mr. Bond.”

Plus, if you want to try to get all or even some of your taxes discharged in bankruptcy, you must have filed your tax returns.

Filing your tax returns is one of five necessary elements to wiping out tax debts in bankruptcy. Again, without filing your tax returns, the Bankruptcy Court will be required by law to say, “No deals, Mr. Bond.”

No filed tax return = no discharge in bankruptcy.

So, does the IRS want it bad or what?

One more example: Hollywood movie star and convicted tax criminal Wesley Snipes: He has been sentenced to spend years in federal prison for committing the crime (yes, crime) – in fact, felony – of not filing tax returns.

Looking at these bunch of rules, let there be no doubt or dispute – the government wants us to file our tax returns, and has created a whole bunch of carrots and sticks (mostly sticks) to get us to do it.

Considering how badly the IRS wants taxpayers to file their tax returns, and to do so on time, you’d think they’d give taxpayers a gold star or something for being so organized and diligent that they filed early. But that just isn’t how it works.

With all the rules that articulate and carry out the government’s policies, it seems bizarro, but it is nonetheless true, that if you file your tax return early, not only do you not get a carrot, but in a way, you get a stick.

Because not only does the clock not start until the final due date for filing your tax return, but essentially, you are giving the IRS an automatic extension of its statute of limitations to decide what to do – whether to accept your return as correct and assess your tax bill based on what you submitted, or stop to wonder if there’s something wrong, and make your life more difficult by deciding to so examine – or audit – your return, and then assess your tax bill.

Conclusion: Three Years or More, Depending

To summarize: The IRS has three years to assess tax after you file your tax return. This time limit includes conducting an audit to examine the accuracy of a tax return and then assess tax after the audit.

The three-year statute of limitations starts with the date of filing a tax return if it was filed on the due date (like April 15th) or after the due date. If filed early, then the statute of limitations does not start to run until the actual due date for filing the return.

There are additional traps though: in some situations, the three-year statute of limitations never starts to run and so the IRS has an unlimited amount of time to audit and assess tax. I’ll take that up in another post. Stay tuned.

The short answer is “3 years.” But, three years from what? I will shortly post a fuller discussion about how much time the IRS has to decide whether or not to audit someone and then do something about it.