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Mary Bernard
Mary Bernard

Supreme Court rules against IRS in basis overstatement case

Longer statute of limitation not triggered by basis overstatement, resolving split in the federal circuit courts.

May 24, 2012
by Mary F. Bernard, CPA

In Home Concrete & Supply, LLC, Sup. Ct. Dkt. No. 11-139 (U.S. 4/25/12), the Supreme Court ruled against the IRS’s position that an overstatement of basis was sufficient cause to extend the statute of limitation to six years.

Background

Under Sec. 6501, if a taxpayer omits from gross income an amount in excess of 25% of the gross income reported on the return, the IRS is permitted to assess tax at any time within six years after the return is filed, rather than three years as under normal circumstances. When this six-year limitation applies due to an omission of greater than 25% of gross income, the taxpayer’s entire tax liability for the tax year is subject to the six-year limitation period. A deficiency can include an amount not attributable to an item of omitted gross income, such as amounts attributable to disallowed depreciation deductions (Colestock, 102 T.C. 380 (1994)).

Examples of omissions from gross income previously determined to apply under Sec. 6501 are taxable alimony, constructive dividends, taxable settlement proceeds from a lawsuit, employer-provided advances for living expenses, and compensation assigned to a trust taxable to the grantor (see, e.g., Marshall, T.C. Memo. 1976-34; Pittman, T.C. Memo. 1995-243; Rozpad, T.C. Memo. 1997-528; Morgan, T.C. Memo. 1997-132; Stoecklin, T.C. Memo. 1987-453).

Home Concrete

In 2000, Home Concrete filed its 1999 partnership return. In 2006, the IRS issued a final partnership administrative adjustment (FPAA) asserting a basis overstatement on a transaction. Home Concrete filed a refund request in federal district court claiming that the FPAA was untimely under the three-year statute of limitation in Sec. 6501(a). The IRS countered that the FPAA was timely because an extended six-year statute applied under Sec. 6501(e)(1)(A). According to the IRS, by overstating the basis on the transaction at issue, Home Concrete had omitted from gross income an amount in excess of 25% of the gross income reported on the 1999 return.

The district court agreed with the IRS in a partial summary judgment, indicating that the overstatement of basis resulted in a qualifying omission of income under Sec. 6501(e)(1)(A). The Fourth Circuit, however, reversed this finding on appeal and held that the question of whether an overstatement of basis resulted in an omission of gross income was previously resolved by the Supreme Court’s 1958 decision in Colony, Inc., 357 US 28 (1958).

Under the predecessor statute of Sec. 6501(e)(1)(A) with virtually identical wording, the Colony Court interpreted “omit” to apply only when an item of gross income was left off the tax return, that is, it applies when specific items of income were left out of the computation of gross income. The Court held that the extended statute did not apply to an overstatement of basis because, while it resulted in an error in the computation of gross income, nothing had been omitted from the tax return.

The Fourth Circuit also held that the temporary and final regulations issued by Treasury in 2009 and 2010 that would override the Supreme Court’s interpretation of the statute in Colony were not entitled to deference.

The Supreme Court ruled that it was bound by the doctrine of stare decisis to follow its opinion in Colony and that the IRS could not in effect overrule Colony by issuing regulations. The Colony Court determined that the legislative history of the predecessor statute indicated that Congress clearly intended that the overstatement of basis would not extend the limitation period. Because the Court had already definitively interpreted the statute in Colony, the IRS could not adopt a different interpretation in regulations.

Implications

One result of the ruling in Home Concrete is that to the extent that Regs. Sec. 301.6501(e)-1 conflicts with this decision, the regulation is invalid. Therefore, the Supreme Court subsequently granted certiorari in five cases where circuit courts had held that the extended statute applied to basis overstatement, vacated the decisions, and remanded the cases to those courts for reconsideration in light of the Home Concrete decision. In addition, four cases challenging this position were denied certiorari. This decision could be significant for taxpayers with basis overstatement issues pending in litigation.

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Mary F. Bernard, CPA, is director-income/franchise tax at the Dallas-based tax services firm of Ryan. She formerly worked as principal, director of State & Local Tax Services, at Providence, R.I.-based Kahn, Litwin, Renza & Co., Ltd.