The United States Supreme Court has resolved an issue that has been working its way through the circuit courts for several years. In United States v. Home Concrete (April 25, 2012), the Court held that overstating the income tax basis of an asset does not cause an “omission from income” for purposes of making applicable the six-year rather than the three-year statute of limitations. Because the issue involves a substantial amount of tax dollars, the Internal Revenue Service fought this battle at every turn – until the Supreme Court finally put the issue to rest in late April.
The IRS normally has three years after a taxpayer files an income tax return to audit the return and propose additional tax liability. The agency has six years, however, if the taxpayer omits from the return an amount of gross income that is more than 25 percent of the amount of gross income reported on the return. The controversy centered on whether a taxpayer who overstated the tax basis of an asset, and thereby underreported the amount of tax gain that resulted from the sale of the asset, had omitted gross income from the return.
Many of the tax-advantaged transactions structured in the early part of the previous decade purported to increase the income tax basis of an asset. The IRS took some time to uncover many of these and consequently had to propose tax deficiencies more than three years after the filing of many returns. In order for its actions to be timely, the IRS had to take the position that the six-year statute of limitations applied.
By the time the issue reached the Supreme Court, six circuits of the United States Court of Appeals had addressed it. The battle had begun to swing in favor of the IRS after it promulgated its own self-help regulation in 2009. Four circuits – the District of Columbia, Federal, Seventh and Tenth Circuits – had held in favor of the IRS, and two circuits – the Fourth and Fifth Circuits had held in favor of the taxpayer. A split involving six different circuits presented a classic case for the Supreme Court to accept the certiorari petition of Home Concrete, the case from the Fourth Circuit, and resolve the issue.
The Court held that the six-year statute of limitations did not apply, based on its holding in Colony Inc. v. Commissioner (1958). In Colony, the Court had interpreted identical statutory language in the Internal Revenue Code of 1939, and drew a distinction between understating gross income and omitting gross income. While the overstatement of basis clearly caused an understatement of the taxpayer’s gross income, the understatement did not result from “omitting” anything from the return. The Court reasoned that “omit” means “to leave out or unmentioned; not to insert, include, or name.” While the basis number on the tax return was admittedly not correct, nothing had been omitted from the return.
The Court also dismissed the IRS’s attempt at self-help through the regulation it issued in 2009. In the Court’s view, the statute was not ambiguous and the IRS could not issue a regulatory interpretation contrary to the clear meaning of the statute. In last summer’s edition of our newsletter, we described the basis overstatement question as “the issue that will not go away” (See Vol. 6., No. 2, August 2011). The Supreme Court’s decision in Home Concrete has finally banished it. For an in-depth analysis of the Court’s decision in Home Concrete, see our May 2012 alert.