In November of 2007 (Vol. 2 No.2) we reported on the Tax Court case of Bakersfield Energy Partners, L.P. v. Commissioner, where the court held that if a taxpayer erroneously overstates the tax basis of an asset he sold, the IRS has only 3 years rather than 6 years to assess additional tax. The IRS normally has three years after an income tax return is filed to audit the return and assess any additional tax it believes is due. However, if the taxpayer omits from the return an amount of gross income that exceeds 25% of the amount of gross income reported on the return, then the IRS has six years to assess additional tax. Many popular tax shelters of the past decade resulted in the creation of artificially high basis in assets that were later sold to create supposed tax losses.
The Tax Court found for the taxpayer, determining that overstating basis is not the same thing as omitting gross income. Two United States Courts of Appeals have now agreed with the Tax Court. First, the Ninth Circuit (which includes California) affirmed the Tax Court’s holding in Bakersfield Energy Partners. The court rejected the argument of the IRS that the result differed depending on whether the asset was used in a trade or business or simply held for investment. More recently, the Federal Circuit reached the same conclusion in Salman Ranch Ltd. v. United States (July 30, 2009). Shortly after the Ninth Circuit’s decision in Bakersfield Energy Partners, the issue again came before the Tax Court in Beard v. Commissioner (August 11, 2009). As expected, the Tax Court held that this issue is resolved in the Ninth Circuit. The six year statute of limitations does not apply to the overstatement of the tax basis of an asset. Taxpayers have generally not fared well in the litigation over tax shelter types of transactions. However, on this procedural issue, so far they are doing very well.