In February 2023, a case against the Commissioner of Internal Revenue filed by a group of taxpayers was lost. Fairbank v. Commissioner was filed on behalf of a group of taxpayers who had been served a note of deficiency in 2018 on behalf of the years 2003-2009, and 2011 by the Internal Revenue Service. Their argument hinged primarily on the statute of limitations, which they used to challenge the IRS’ right to go back on these years.
The loss of the taxpayers, in this case, is interesting, as it casts our gaze on the role of the statute of limitations in tax law. The statute of limitation can be, and is, applied in tax law cases, but it comes with many caveats. Its role is dependent on a number of factors, including the gross amount of income omitted, and, crucially (particularly in the case of Fairbank) whether the omitted income (or information) had to do with certain foreign accounts or interests.
Case Background
The early history of the case began when Leigh Fairbank deposited $600,000 into an Anstalt account in Liechtenstein as part of his wife Barbara’s divorce agreement. The only asset found in this account was a bank account with the Swiss investment bank UBS. The account, called Xanava Establishment, was deemed by the court to be a foreign trust.
In 2009, a separate corporation named Xong was formed by Barbara’s attorney in the British Virgin Island, of which she was sole shareholder. The funds associated with this account were deposited into a Swiss bank account (one distinct from the UBS one established years prior for Xanava). The funds from UBS were to be sent to an account in Dubai and to the new Swiss account. Over the years, several transactions were made from these accounts, but the Fairbanks did not declare them on their U.S tax forms – they instead filed their U.S tax documents as having no foreign bank accounts at all, and requested that the banks in Switzerland and Dubai did not send documentation to their U.S address.
In 2018, after a crackdown on foreign bank accounts held by American citizens at UBS, the IRS issued a notice of deficiency for the years 2003, 2004, 2005, 2006, 2007, 2008, 2009 and 2011. It was at this point that the Fairbanks filed form 5471, declaring that they had an interest in foreign corporations. They continued to deny interest in foreign financial accounts, however.
The Outcome
As noted above, the Fairbanks challenged the IRS on the basis that the statute of limitations had expired for this period. However, the court retorted that the couple’s unsubstantiated failure to comply with IRS reporting standards prevented the closure of the assessment limitation period.
The court’s decision was based on IRC Section 6501(c) (8), which details protocol in the case of failure to comply with reporting duties on foreign transfers. In this case, it is noted that ‘the time for assessment of any tax […] shall not expire before the date which is 3 years after the date the Secretary is furnished the information required to be reported’.
In the case of Fairbank, the Secretary was not furnished with the information required to be reported, meaning the statute of limitations did not apply.
Though simplified, this outcome has a clear message for American citizens using foreign accounts: the consequences deriving from the failure to properly report and file all interests outside of the U.S will not disappear owing to the statute of limitations. Indeed, the complexity of Fairbank in itself is highly indicative that any attempts to avoid tax using foreign assets may end in a long and complicated legal battle.
