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Legal Update

Illinois Appellate Court Resolves Issue of When Limitations Period for Accounting Malpractice Claim in a Tax Liability Case Begins to Run

20 April 2010
Mayer Brown Legal Update

The Illinois Appellate Court for the First District has held that the statute of limitations in an accounting malpractice case resulting in increased tax liability begins to run either when the taxpayer receives the statutory deficiency notice pursuant to Internal Revenue Code section 6212 or when the taxpayer agrees with the IRS’s proposed deficiency assessments, not when the taxpayer has reason to believe there is a controversy relating to the return. The court’s decision adopts the majority view on the issue and resolves a previously open question under Illinois law.

In Federated Industries, Inc. v. Reisin, 2010 WL 1255212 (Ill. App. 1st Dist. Mar. 31, 2010), the appellate court affirmed a circuit court’s dismissal under Illinois Code of Civil Procedure section 2-619(a)(5) for failure to file a claim within the applicable two year limitations period. Federated, an S-Corporation, had hired defendant accounting firm Ostrow, Reisin, Berk & Abrams, Ltd. (ORBA) for tax and consulting services and to monitor its passive investment income to ensure Federated’s continued S-Corporation status. ORBA allegedly failed to monitor Federated’s passive investment income levels. The IRS conducted audits of Federated and notified Federated that its S-Corporation status would be terminated.

On December 27, 2005, after IRS audits and negotiations, Federated “unanimously consented” to the IRS’s proposed audit adjustments in order to maintain its S-Corporation status but Federated had not yet paid to resolve the tax dispute. On April 25, 2006, the IRS provided Federated an examination report and requested that Federated return an executed acceptance form if it agreed with the IRS’s findings. On May 17, 2006, Federated returned the executed acceptance form to the IRS. Plaintiffs filed suit against ORBA on May 15, 2008. The circuit court dismissed plaintiffs’ complaint as not timely filed.

The appellate court in Federated concluded that the claim was time barred because Federated had consented to the proposed adjustment to its return more than two years prior to filing suit, even though Federated had formally accepted the IRS’s findings less than two years prior to filing the suit. In so holding, the court considered the two positions regarding limitations periods taken by other courts—(i) the limitations period starts to run upon indication from the IRS of a disagreement with the taxpayer’s return or (ii) the limitations period begins to run upon the issuance of the statutory notice of deficiency. In adopting the latter approach, the Federated court reasoned that it would create a bright-line rule, promote judicial economy, and preserve the accountant-client relationship.

The court concluded that because the plaintiffs unanimously consented to the IRS’s proposed tax adjustments in December 2005, the issuance of a statutory deficiency notice was not required and the limitations period began to run at the time of Federated’s acceptance of the IRS’s findings. The fact that the amount of plaintiffs’ tax liability was not immediately ascertainable and that it had not yet been paid did not postpone the triggering of the statute of limitations.

For more information about the Federated decision, or any other matter raised in this Alert, please contact at +1 312 701 7326 or at +1 312 701 7093.

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