The Bottom Line: Correcting Errors on Income Tax Returns

Any company can make mistakes when filling out a tax return, and that includes mold builders. However, mistakes are not always to the detriment of the company. Sometimes they can be beneficial. There are numerous reasons why a mold builder may need to correct a tax return or its methods of computing tax liabilities. and correcting these errors may allow the mold builder to request refunds or credits. However, these corrections also may also be costly and require the mold builder to pay additional tax, and perhaps interest and penalties as well (see sidebar below). Here are three common ways to correct items on a tax return:]

1. File an amended tax return. Requesting refunds/credits or assessing additional tax liabilities is accomplished by filing a revised return along with a schedule summarizing the difference between it and the originally filed return (or the last revision thereof).

Companies that find errors in prior tax years should amend their returns to report the errors, whether or not correcting those errors will be beneficial to them. However, if the tax liability does not change as a result of amending the items on the return, companies are not required to file the amended return. 

For instance, if a company had a net operating loss in its first year of operation and it failed to properly deduct a travel expenditure, it may revise its net operating loss carried forward into the subsequent tax year without filing an amended return. It may be advised to attach a schedule showing the adjustment to the loss in order to show why the loss is different from what was originally reported.

2. Change the accounting method. Generally, companies have adopted a specific method of accounting once they have used the method for two tax returns (see “A Method to the Tax Madness” in the March issue). In order to change this method, a company must file a Form 3115, the application for change in accounting method.

There are two types of accounting-method changes: automatic and non-automatic, in which permission must be requested. For automatic changes, a company may file Form 3115 with its “timely filed” tax return (including extensions). For non-automatic changes, a company must file Form 3115 by the end of the tax year and pay a significant user fee.

Many of the changes in accounting method are often a reflection of timing. That means many accounting methods reflect when revenue is recognized and when expenditures may be deducted. A company may change from one permissible method to another permissible method. Generally, this change reflects a benefit to the company, such as when an adjustment to the current tax year’s income is equal to the difference between taxable income under the old method of accounting and the new method of accounting.

Also, a company may change from an impermissible method of accounting to a permissible method of accounting for calculating taxable income. This change may reflect a benefit or cost to the company. For example, if a mold builder is not complying with the uniform capitalization requirements (the requirement for companies to capitalize indirect costs into ending inventory), it may change its method of computing its cost of goods sold to capitalize its indirect expenditures into its ending inventory.

3. Get examined by the IRS. This is the least attractive means of correcting mistakes. IRS examinations/audits can be costly, both in terms of employee time to comply with information document requests (IDRs) and professional fees for advising mold builders on the examination. Also, the IRS will control the areas of focus.

Companies may not file a claim for credit or refund after the statute of limitations has expired, and the IRS may not assess a tax liability after the statute of limitations has expired. This statute of limitations expires three years after the return was filed or two years after the tax was paid, whichever occurred later. When filing an amended return near the expiration of the statute of limitations, use certified mail with a return receipt. Under IRS guidelines, timely mailed means timely filed, so it is critical that the company is able to prove when the return was filed. The IRS regularly publishes a list of acceptable private delivery services if a filer prefers not to send a return via U.S. mail.

What if an error exists in a closed tax year (a year for which the statute of limitations has expired) that affects the tax liability of a tax return within the statute of limitations? Our firm has found that many companies are unaware that the company and the IRS may make adjustments to those items that carry over into tax years for which the statute of limitations is not closed. For example, unused net operating losses or tax credits may carry forward to subsequent tax years if unused in the year generated.

In 1981 and 1982, the IRS issued revenue rulings that showed how Subchapter C Corporations (a business that is taxed as a legal entity separate from the owners) and the IRS may adjust carryforward items, such as net operating losses or credits, in closed tax years that affect the tax liability in open tax years (years for which the statute of limitations has not expired). In a 1981 revenue ruling, the government provided that companies and the IRS may determine the appropriate amount of net operating loss in a closed tax year that is carried forward into an open tax year. This may work toward the benefit or the detriment of the mold builder. The following year, the government provided that companies and the IRS may determine the appropriate amount of investment tax credits (credits that reward various investments in property and equipment) that were unused in closed years that could be carried forward into open tax years. While this ruling dealt with the investment tax credits, it can be applied to a multitude of general business credits, such as the R&D tax credit.

Prior to 2015, there was some ambiguity as to whether flow-through entities, such as Subchapter S Corporations, limited liability companies (LLCs) and partnerships, could apply the same concepts to their tax items. Flow-through entities report the income, deductions and credits to its owners, and the owners pay the income tax attributable to the entity. In November 2015, the IRS issued a private letter ruling (a means for the Treasury to provide an opinion on an issue specific to a company) indicating that the same concept may apply to flow-through entities. The letter ruling dealt with employer’s Federal Insurance Contributions Act (FICA) tip credits, which rewards employers for reporting cash tips so that payroll taxes may be assessed on an employee’s tip income. While mold builders are not eligible for this credit, the concept may be applied to tax credits and other carryforwards that are applicable to mold builders. Like the rules related to Subchapter C Corporations, this can be applied to both credits and loss items. For example, a mold builder may identify R&D credits in tax years outside of the statute of limitations that may be carried forward to tax years for which the statute of limitations has not expired. 

Whether the tax return error was made by the mold builder or the CPA completing the return, or because of a lack of understanding the eligibility requirements of credits and incentives, mold builders should look to correct these mistakes using the appropriate method. 

Mueller Prost