Statute of Limitations
Code Section 6501(e)(1)(A) provides that if the taxpayer “omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return,” the IRS has six years, rather than three years, from the date on which the return was filed to assess a deficiency. In addition, the section defines “gross income” in the context of a trade or business as the total amount received or accrued from the sale of goods or services without consideration of the cost of such sales or services and excludes items of gross income if properly disclosed in the return. Code Section 6229(c)(2) mirrors code Section 6501(e)(1)(A) with respect to partnerships subject to the Tax Equity and Fiscal Responsibility Actof 1982 (TEFRA) procedures.
The language of the statue leaves unanswered a number of questions: Does “to omit” from gross income mean to leave off or exclude?” Does an “amount” of gross income mean a specific item of gross income or does it mean a miscalculation? Does “gross income” mean proceeds or receipts as in the case of a trade or business? Or does it mean net profits or gain? And does the definition of gross income for purposes of a trade or business mean that gross income is defined differently otherwise?
The Landscape at the Time of the Issuance of the Temporary Regulations
The seminal case in the area is Colony, Inc. v. Commissioner, 357 U.S. 28 (1958), where the Supreme Court, dealing with the predecessor of Code Section 6501(e)(1)(A), held that the extended statute of limitations was applicable only in “the specific situation where a taxpayer actually omitted some income receipt or accrual in his computation of gross income and not more generally to errors in that computation arising from other causes.” The IRS has argued that Colony is not controlling because the statute applied by the Supreme Court was effectively the trade or business provisions added to the 1954 Code by Section 6501(e)(1)(A)(i) in which the basis determination is irrelevant. The IRS has found some success with that argument, most notably in the First Circuit and a number of lower courts, but the over whelming weight of authority, principally in the Federal Circuit, the Ninth Circuit and the Tax Court, is that Colony is not limited to trade or business cases and that an overstatement of basis is not an omission from gross income.
To bolster its litigation position, the IRS issued temporary regulations to clarify the term “gross income” outside the context of a trade or business and to provide that an overstatement of basis in determining gain constitutes an omission from gross income. The temporary regulations provide that the term gross income in a non-trade or business context has the same meaning as provided in Code Section 61(a) which defines “gross income” as “all income from whatever source derived” and explicitly includes in gross income “gains derived from dealings in property.” In accordance with the effective date provisions, the temporary regulations are “applicable to all cases with respect to which the period for assessing tax under the applicable provisions has not expired before September 24, 2009.” In determining whether the applicable provisions have not expired, the IRS has argued that the determination is to be made by applying the temporary regulations on a hypothetical basis.
The first case to consider the temporary regulations was Intermountain in which the Tax Court had had held in a prior decision that the final partnership administrative adjustment was untimely. Relying upon the temporary regulations the IRS filed an untimely motion with the Tax Court to reconsider and vacate its prior decision.
In a reviewed opinion with a seven judge majority, the IRS’s motions were denied. The court first found that the temporary regulations did not apply to this case since the period for assessing tax had expired before September 24, 2009, the effective date in the temporary regulations. The IRS had argued that in determining whether the statute of limitations had expired prior to September 24, 2009, the temporary regulations are to be applied on a hypothetical basis. The majority opinion rebuked the IRS for “advancing a notably convoluted interpretation” of the effective date of the temporary regulations that assumed applicability to any year that would be an open year by applying the regulations themselves. The court found the IRS’s interpretation of the effective date provisions were “irreparably marred by circular, result driven logic and the wishful notion that the temporary regulations should apply to this case.”
Further, the court found that the temporary regulations did not deserve judicial deference because the decision in Colony was based upon the determination that the statute was unambiguous. Since the temporary regulations did not interpret an ambiguous statute, they could not displace the Supreme Court’s decision in Colony and therefore were invalid.
Four judges concurred in the result, but would have reached the same result on the narrower ground that the motion to vacate was untimely filed. Two other judges concurred with the result, but on the basis that the temporary regulations did not comply with the Administrative Procedure Act, which required notice and comment before publication.
Despite the set back in Intermountain, the IRS has publicly announced that it will continue to rely upon the temporary regulations. Since Intermountain, the Tax Court has denied the IRS’s motion to vacate and reconsider in two other Tax Court cases and has yet to rule on the IRS’s motion with respect to two other cases.
In light of the public statements made by the IRS, the battle is not over. The IRS can always remedy the failure to follow the Administrative Act, but cannot remedy the impression by the Tax Court that the temporary regulations were purely a bootstrap action to support its litigation position and are an overly aggressive use of the regulatory process. In all likelihood, the IRS will appeal the Intermountain case to clear the air with respect to the deference to be shown to the temporary regulations.
| Rate this article 5 (excellent) to 1 (poor). Send your responses here.