We have reported previously (see, Vol. 4, No. 2, September, 2009, Vol. 2, No. 2, November, 2007) about a few cases that have considered whether the longer six year statute of limitations applies where a taxpayer overstates the tax basis of an asset. Normally, IRC Section 6501(a) requires that the IRS assess any additional tax it believes is owed within three years after a taxpayer files his return. However, under IRC Section 6501(e), if the return omits gross income that is more than 25% of the amount of gross income reported on the return, then the IRS has six years. A controversy developed over whether overstating the basis of an asset (and thereby underreporting the correct amount of gain) constitutes an omission from gross income.

After taxpayers prevailed in a couple of the early cases, the IRS resorted to self help and wrote a tax regulation that adopted its position. The regulation said that other than the case where goods are being sold in a trade or business, the overstatement of basis does result in an understatement of the taxpayer’s gross income.

In Grapevine Imports v. United States, (March 11, 2011), the IRS had issued its notice proposing a deficiency more than three but less than six years after the tax return had been filed. In the Court of Federal Claims, the court ruled in favor of the taxpayer based on the interpretation of an old Supreme Court case called Colony. However, that happened before the IRS issued its regulations. The case went before the Federal Circuit after the purportedly retroactive regulations were issued.

Another panel of the Federal Circuit had previously held for the taxpayer on this same issue, but that was also before the regulations were issued. This time, the Federal Circuit held in favor of the government. It found that the regulations were within the authority of the IRS to issue under IRC Section 7805 which empowers the IRS to issue regulations to interpret the Internal Revenue Code. A recent Supreme court case, Mayo Foundation v. United States, played a role in the outcome. The Mayo case will make it far more difficult for a taxpayer to get a court to overturn or invalidate a regulation that has been issued by the IRS. Under Mayo, in order for a tax regulation to be valid, there only need be an ambiguity in the statute it interprets, and the regulation must present a reasonable interpretation of the statute. The Federal Circuit found both of those requirements were satisfied so the government prevailed based upon its own regulation. The law applicable to regulations for this period of time also permitted regulations to be applied retroactively.

There is a good chance that this issue will now go to the Supreme Court for resolution. Two other circuits (the Fourth Circuit in Burks v. United States (February 9, 2011) and the Fifth Circuit in Home Concrete Supply v. United States (February 7, 2011)) have rejected the same regulation post-Mayo, finding that the statute was not ambiguous on its face, so under Mayo a regulation is not permitted.