Home Concrete & Supply, LLC, (Sup Ct4/25/2012) 109 AFTR 2d 2012-661
The Supreme Court, resolving a split among various Circuit Courts and the Tax Court, has determined that an overstatement of basis isn't an omission of gross income for purposes of Code Sec. 6501(e)(1)(A)'s 6-year limitations period. The Court found that the '58 Colony decision, in which the Court construed the nearly identical language of Code Sec. 6501(e)(1)(A)'s predecessor statute as referring only to items left out, controlled the outcome of this case.
Background.Code Sec. 6501(a) generally provides that a valid assessment of income tax liability may not be made more than 3 years after the later of the date the tax return was filed or the due date of the tax return. However, under Code Sec. 6501(e)(1)(A), a 6-year period of limitations applies when a taxpayer "omits from gross income" an amount that's greater than 25% of the amount of gross income stated in the return. Code Sec. 6501(e)(1)(B)(i) (which was an amendment in the '54 Code to the predecessor of Code Sec. 6501(e)) provides that "in the case of a trade or business, the term "gross income" means the total of the amounts received or accrued from the sale of goods or services (if such amounts are required to be shown on the return) prior to the diminution by the cost of such sales or services."
The Supreme Court, interpreting the predecessor statute to Code Sec. 6501(e)(1)(A), held that the extended period of limitations applies to situations where specific income receipts have been "left out" in the computation of gross income, and not something put in and overstated. (Colony, Inc. v. Com., (1958, S Ct) 1 AFTR 2d 1894, 357 US 28).
IRS issued final regs in December of 2010 under which an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis is an omission of gross income for purposes of the 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items (Reg. § 301.6501(e)-1(e)). The final regs adopt the position IRS had held in temporary regs. IRS disagrees with the courts that hold that the Supreme Court's reading of the predecessor to Code Sec. 6501(e) in Colony applies to Code Sec. 6501(e)(1)(A). IRS takes the position that when Congress enacted the '54 Code, it effectively limited what ultimately became the holding in Colony to cases subject to the '39 Code. Moreover, under Code Sec. 6501(e)(1) of the '54 Code, which remains in effect under the '86 Code, when outside of the trade or business context, the definition of "gross income" in Code Sec. 61 applies. So, the regs provide that any overstatement of basis that results in an understatement of gross income under Code Sec. 61(a) is an omission from gross income under Code Sec. 6501(e)(1)(A).
In a 5-4 decision, with Justice Breyer writing for the majority (which included Chief Justice Roberts and Justices Thomas, Alito, and Scalia), the Supreme Court affirmed the Fourth Circuit and found that Code Sec. 6501(e)(1)(A) doesn't apply to an overstatement of basis. The Court stated that its conclusion "follows directly from this Court's earlier decision in Colony."
The majority found that the language of the provision at issue in Colony was substantially identical to Code Sec. 6501(e)(1)(A). In Colony, the Court found that the plain language of the term "omits" refers only to something which is left out. Although a basis overstatement can have the same ultimate effect of understating a taxpayer's income, it doesn't constitute an omission. The Colony Court also observed that the legislative history of the provision at issue in that case only demonstrated an intent to create an exception to the usual 3-year period in cases involving failures to report income receipts and accruals, where IRS is at a disadvantage because the return doesn't indicate the existence of the omitted item(s), and not to extend the period in every instance where income is understated.
According to the majority, to hold otherwise would effectively overrule Colony. The Court noted that principles of stare decisis are especially compelling in cases involving statutory interpretation because Congress is free to legislate a different result.
With regard to Reg. § 301.6501(e)-1, IRS argued that a prior judicial construction "trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute" (Nat'l Cable & Telecomms. Ass'n v. Brand X Internet Servs., (2005) 545 U.S. 967), and that the Colony court itself said of the provision at issue that "it cannot be said that the language is unambiguous." Therefore, argued IRS, Colony couldn't control, and the operative issue is whether the reg is a "permissible construction of the statute" under Chevron.
However, the Court stated that Colony's prior interpretation of the statute effectively foreclosed IRS's contrary construction in Reg. § 301.6501(e)-1 , noting that the "linguistic ambiguity" observed by the Colony court 30 years before Chevron didn't necessarily warrant a post-Chevron conclusion that Congress has delegated "gap-filling power" to IRS. On the contrary, the Colony decision indicated overall that the Court didn't believe that the statute left such a gap.
In the end, because the reg was a reasonable interpretation of Code Sec. 6501(e)(1)(A), and because the Court's Colony decision construed a predecessor version of the provision, the dissent determined that the reg should control in this case.
The Court's decision will likely have an adverse impact on IRS's efforts to collect taxes in other Son-of-BOSS and similar tax shelter cases.
However, the IRS may now seek a law change in response to this loss.