IRS Did Not Prove Six-Year Limitations Period

After two extensions, P and L filed a joint Federal return for 1990, received by the IRS on Sept. 10, 1991. The original return reported that either P or L held limited and general partner interests in six partnerships, but that neither had "materially participated" under Sec. 469. The IRS no longer has copies of any of the six partnerships' 1990 returns, and the Schedules K-1 are not in the record. The record does not indicate the six partnerships' gross income.

On Sept. 8, 1997, P and L filed an amended 1990 return prepared by their accountant and remitted payment. The amended return shows an additional tax liability of $218,152 (without statutory additions) based on $779,114 of gross income omitted from the original return. The amount omitted from the original return relates to unreported cancellation of debt in-come. The IRS assessed the additional tax shown on the amended return on Nov. 6, 1997.

P and L dispute any balance due and request a refund of $218,152 paid in error. They claim the amended return was invalid and the assessment of penalties and interest is incorrect because the amended return was filed after expiration of the three-year statute of limitations (SOL).

Analysis

Sec. 6501(e) generally provides that a six-year SOL applies when a taxpayer omits from gross income an amount greater than 25% of the gross income stated in the return. P and L established that the general three-year SOL has expired, so the IRS bears the burden of establishing that the amount P and L omitted exceeds 25% of the gross income reported in their return. To satisfy the burden of going forward, the IRS must show the amounts of gross income reported on the partnership and S corporation returns or that no such returns were filed. The IRS provided none of the income tax returns for the six partnerships in which P and L were partners and has not alleged that any of the six partnerships failed to file returns for 1990. Instead, the IRS alleges that the burden of going forward does not include the production of the partnership returns.

The amount petitioners omitted, the numerator in the calculation, is not in dispute in this case; it is $779,114. The parties disagree, however, as to the amount of gross income stated in P and L’s return. Gross income is not defined in Sec. 6501. However, the Code's general definition of gross income applies to Sec. 6501(e), except for the modification provided in Sec. 6501(e)(1)(A)(i). That section provides that as applied to a trade or business, "gross income" includes the total of the amounts received or accrued from the sale of goods or services before diminution by the cost of those sales or services. As to a taxpayer-partner, we have interpreted this provision as requiring that a taxpayer's gross income include his or her share of the partnership's gross receipts from the sale of goods or services.

We have not previously addressed whether Sec. 6501(e)(1)(A) applies only to situations in which a taxpayer-partner did materially or actively participate in the partnership. In general, a general partner may be deemed to be conducting the trade or business activity of the partnership of which he or she is a member. Moreover, the trade or business of the partnership may be imputed to a general partner, regardless of the fact that the partner did not actively or materially participate in the partnership; see Bauschard, 279 F 2d 115 (6th Cir. 1960). It is also possible for the trade or business activity of a limited partnership to be imputed to a limited partner; Newhall Unitrust, 105 F 3d 482 (9th Cir. 1997).

Sec. 6501(e)(1)(A)(i) does not indicate that a partner must materially or actively participate in the trade or business. We hold that Sec. 6051(e)(1)(A)(i) does not require that a partner materially participate (as defined by Sec. 469) in the trade or business activity. Thus, the IRS failed to meet its burden of production as to establishing the amount of gross income stated on the 1990 tax return. Because the IRS failed to show that the six-year SOL applies, the general three-year SOL applies.

Peter M. Hoffman, 119 TC No. 7