T.D. 9466, 09/24/2009; Reg. § 301.6229(c)(2)-1T, Reg. § 301.6501(e)-1T; Preamble to Prop Reg 09/24/2009
IRS has issued temporary regs under which an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission of gross income for purposes of the 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items.
RIA observation: Recently, IRS has lost many cases in the courts on the issue of whether a basis overstatement is an omission of income for purposes of the 6-year limitations periods. As explained below, IRS is seizing on language in one decision that it could issue clarifying guidance on this subject.
Background. Code Sec. 6501(a) generally provides that a valid assessment of income tax liability may not be made more than 3 years after the later of the date the tax return was filed or the due date of the tax return. However, under Code Sec. 6501(e), a 6-year period of limitations applies when a taxpayer omits from gross income an amount that’s greater than 25% of the amount of gross income stated in the return. For a trade or business, gross income, for this purpose, means the total of the amounts received or accrued from the sale of goods or services (if such amounts are required to be shown on the return) prior to diminution by the cost of such sales or services. (Code Sec. 6501(e)(1)(A)(i))
Subject to the exceptions and special rules, the period for assessing tax attributable to a partnership item (or affected item), for a partnership tax year won’t expire before the date that is three years after the later of: (1) the date the partnership return was filed, or (2) the last day for filing the return for that year (without regard to extensions). (Code Sec. 6229(a)) The period is six years where the partnership omits from its gross income an amount which is more than 25% of the amount of gross income stated in its return. (Code Sec. 6229(c))
Omission definition applies for both provisions. The preamble notes that an omission from gross income is not further defined in Code Sec. 6229(c) as it is in Code Sec. 6501(e)(1)(A). However, it stresses that, having defined a phrase in Code Sec. 6501, Congress need not redefine the same phrase when it is later used to extend that same statute of limitations. Thus, the temporary regs confirm that Code Sec. 6501(e)(1)(A) defines an omission from gross income both for purposes of section Code Sec. 6501 and for any extension of Code Sec. 6501 under Code Sec. 6229. (Reg. § 301.6501(e)-1T(a)(1), Reg. § 1.6229(c)(2)-1T(a)(1), T.D. 9466, 09/24/2009)
Clarification in the regs. The temporary regs clarify that, outside of the trade or business context, gross income for purposes of Code Sec. 6501(e)(1)(A) and Code Sec. 6229(c)(2) has the same meaning as gross income as defined in Code Sec. 61(a). Under Code Sec. 61(a), gross income includes “gains derived from dealings in property” and its regs further explain that gain equals “the excess of the amount realized over the unrecovered cost or other basis for the property sold or exchanged.” Accordingly, outside the context of a trade or business, any basis overstatement that leads to an understatement of gross income under Code Sec. 61(a) constitutes an omission from gross income for purposes of Code Sec. 6501(e)(1)(A) and Code Sec. 6229(c)(2). (Reg. § 301.6501(e)-1T(a)(1), Reg. § 1.6229(c)(2)-1T(a)(1), T.D. 9466, 09/24/2009)
Court interpretations behind the clarification. Different interpretations given by courts to Code Sec. 6501(e)(1)(A) were behind IRS’s decision to clarify the regs. Relying on the Supreme Court’s opinion in Colony Inc v. Com., (1958, S Ct) 1 AFTR 2d 1894, 357 US 28, which dealt with an omission from gross income in the context of a trade or business, the Ninth Circuit and Federal Circuit recently construed Code Sec. 6501(e)(1)(A) in cases outside the trade or business context contrary to the interpretation provided in the new temporary regs, holding that an “omission” does not occur by an overstatement of basis. See Bakersfield Energy Partners LP v. Com., (2009, CA9) 103 AFTR 2d 2009-2712 discussed in Federal Taxes Weekly Alert 06/25/2009 and Salman Ranch Ltd. v. U.S., (2009, CA Fed Cir) 104 AFTR 2d 2009-5640 discussed in Federal Taxes Weekly Alert ¶ 10 8/6/2009.
IRS says it disagrees with these courts that the Supreme Court’s reading of the predecessor to Code Sec. 6501(e) in Colony applies to Code Sec. 6501(e)(1)(A) and Code Sec. 6229(c). IRS takes the position that when Congress enacted the ’54 Code, it was aware of the disagreement among the courts that existed at the time regarding the proper scope of section 275(c) of the ’39 Code. The changes that Congress enacted as part of the ’54 Code predated the Supreme Court’s opinion in Colony and were intended to resolve the matter for the future. Therefore, by amending the Code, including the addition of a special definition of “gross income” with respect to a trade or business, Congress effectively limited what ultimately became the holding in Colony, to cases subject to section 275(c) of the ’39 Code. Moreover, under Code Sec. 6501(e)(1)(A) of the ’54 Code, which remains in effect under the ’86 Code, when outside of the trade or business context, the definition of “gross income” in Code Sec. 61 applies. In this regard, IRS says it agrees with the opinions in Home Concrete & Supply, LLC v. U.S. (DC NC 2008) 103 AFTR 2d 2009-465 and Brandon Ridge Partners v. U.S., (DC Fl 7/30/2007) 100 AFTR 2d ¶2007-5107 (see Federal Taxes Weekly Alert 8/9/2007), which held that an overstatement of basis can constitute an omission from gross income for purposes of the six-year period of limitations.
Consistent with the Ninth Circuit’s suggestion in Bakersfield, the temporary regs clarify what constitutes an “omission from gross income” under Code Sec. 6501(e)(1)(A) and Code Sec. 6229(c)(2) , as amended in connection with the enactment of the ’54 Code and continuing in effect under the ’86 Code. IRS says that the reasonable interpretation of these provisions provided in the temporary regs, acknowledged by both the Ninth and Federal Circuits to be ambiguous, is entitled to deference even if the agency’s interpretation may run contrary to the opinions in those decisions. (T.D. 9466, 09/24/2009)
Period of applicability. The regs apply to tax years with respect to which the applicable period for assessing tax did not expire before Sept. 24, 2009 (the date of filing of the regs with the Federal Register). (Reg. § 301.6501(e)-1T(b), Reg. § 1.6229(c)(2)-1T(b))
RIA observation: Thus, it appears that IRS will continue to litigate this issue in all jurisdictions, even those that held against it before the regs were clarified. Whether courts will give deference to IRS’s clarified position or find that IRS overstepped its bounds, remains to be seen.
RIA observation: The preamble also noted that Code Sec. 6501(e)(1)(A)(ii) provides that the amount omitted from gross income does not include any amount disclosed on the return, or in a statement attached to the return, in a manner adequate to apprise IRS of the nature and amount of the item. While the regs did not provide guidance on this, IRS stressed that this disclosure exception applies to omissions from gross income resulting from basis overstatements. Accordingly, the Preamble states that taxpayers who adequately disclose the nature and amount of the omissions from gross income resulting from dealings in property will not be subject to the extended six-year statute of limitations. Exactly what that would require is unclear.
RIA Research References: For the six-year assessment period, see FTC 2d/FIN ¶ T-4201; United States Tax Reporter ¶ 65,014.15; TaxDesk ¶ 838,016.
Source: Federal Tax Updates on Checkpoint Newsstand tab 9/28/09
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