BEARD v. COMMISSIONER OF INTERNAL REVENUE (January 26, 2011)
In 2000, the IRS invalidated Son-of-BOSS transactions. Simply put, a Son-of-BOSS transaction is one in which the taxpayer reduces his tax liability by inflating the basis in a partnership before he sells his interest. For example, a taxpayer can achieve the inflated basis by contributing the proceeds of and obligation to consummate a short sale to the partnership. He then increases the basis by the amount of the proceeds without reducing the basis to account for the liability to close. In 1999, Kenneth Beard allegedly engaged in such a transaction. He participated in a short sale involving treasury notes, used the proceeds to buy treasury notes, and transferred both the notes and the obligation to close the short sale to two companies he owned. He then sold his interest in the companies. On their 1999 tax return, Beard and his wife reported long-term capital gains on the sale of the companies but used the inflated basis (increased by the amount of short sale proceeds contributed) to calculate their tax liability. Almost 6 years later, the IRS challenged the return and reduced the amount of the basis by the amount of the short sale proceeds. The Beards contested the recalculation. Instead of challenging the factual basis for the recalculation, however, the Beards raised a statute of limitations defense on the alleged facts. They argued that the alleged overstatement of basis does not trigger the longer six-year statute of limitations for an omission from gross income. The tax court granted summary judgment to the Beards. The Commissioner appeals.
In their opinion, Seventh Circuit Judges Rovner, Evans, and Williams reversed. The Court began with the Supreme Court's decision in Colony, on which the tax court relied. In Colony, the Supreme Court held that an overstatement of basis was not an omission from gross income and did not trigger the longer statute of limitations. The Supreme Court was interpreting the predecessor to the current statute of limitations section in the Code, but the current Code uses much the same language. Since the Code revision, some federal courts have concluded that a basis overstatement can be an omission from income notwithstanding Colony. Other courts have followed Colony. The Court decided that Colony was not controlling both because of its unique facts and the added language in the Code revisions suggesting that the purpose of the extension was to give the IRS additional time when the taxpayer's return provided no clue to the additional income. Without Supreme Court authority, the Court turned to the language of the Code. Relying on the Code’s definition of "gross income" and general rules of statutory construction, the Court concluded that an inflation of basis is an omission of gross income in that it leaves out an amount that could be included in the return's gross income. In its plain meaning approach, the Court specifically rejected the "underwater archaeology" (i.e., a deep dive into legislative history) engaged in by the Federal andNinth Circuits in arriving at a contrary conclusion.