It has become obvious that an enormous amount of potential tax collections must be at stake in connection with audits when the IRS has proposed to assess the taxpayer after the normal threeyear statute of limitations has expired, but prior to the expiration of the extended six-year statute of limitations. Normally, the IRS must assess any additional tax it believes is owed within three years after a taxpayer files his return. However, if the taxpayer omits from the return an amount of gross income that exceeds 25% of the gross income reported on the return, the IRS has six years within which to assess additional tax. The question that refuses to go away is how long the IRS has to assess a tax when a taxpayer sells an asset and reports the correct amount of sales price but overstates his tax basis in the asset; does such overstatement of basis amount to an “omission” of gross income? We have reported on cases addressing this issue in virtually every of edition of this newsletter for the last several years. The issue became important because a number of the tax shelter transactions that were broadly marketed purported to increase the tax basis of an appreciated asset prior to the sale of that asset.
After early taxpayer litigation successes, in 2009 the IRS issued “self-help” regulations which say that an overstatement of tax basis does constitute an omission from gross income. The Tax Court immediately rejected this IRS attempt at self-help in the middle of ongoing litigation. However, a case decided by the Supreme Court earlier this year now appears to be shifting the tide in favor of the IRS. In our last edition, (Vol. 6., No. 1, April, 2011), we reported on the Grapevine Imports case and how the court changed its view on that case based upon the Supreme Court’s decision in Mayo Foundation v. United States, (January, 2011). There, the Supreme Court said a tax regulation is valid and must be upheld if: i) the statute it purports to interpret is ambiguous; and ii) the regulation is a reasonable interpretation of the statute. The fact that the regulation was issued by the IRS during the course of a litigation to help its own position is not relevant in connection with the determination of its validity.
Now, two more courts have upheld the applicability of the six-year statute of limitations to overstated basis cases based on the regulation and the Mayo case. In Intermountain Insurance Services of Vail v. Commissioner, the Court of Appeals for the District of Columbia has reversed a prior Tax Court decision in the taxpayer’s favor and upheld the regulation. In Salman Ranch v. Commissioner, the Court of Appeals for the Tenth Circuit has reversed the Tax Court and also upheld the validity of the IRS’ regulation.
At this point there is a significant split among the various circuits of the Court of Appeals. The District of Columbia Circuit, Federal Circuit, Seventh Circuit and Tenth Circuit have upheld the regulation, while the Fourth Circuit and Fifth Circuit have held the regulation to be invalid. One taxpayer has filed a petition to bring this issue before the Supreme Court and there is a good chance that this issue ultimately will be resolved there.