Supreme Court Holds Six-Year Statute of Limitations Does Not Apply to Overstatement of Basis

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By Gale E. Chan, Esq., Jon Finkelstein, Esq., and Patrick J. McCurry, Esq.  

McDermott, Will & Emery, Washington, D.C. and Chicago, IL

In a significant taxpayer victory, the Supreme Court of the United States, in U.S. v. Home Concrete & Supply, LLC, No. 11-139 (U.S. 4/25/12), held that an overstatement of basis does not constitute an omission from gross income that triggers the six-year statute of limitations period under §6501(e)(1)(A).  The IRS generally has three years from the date the taxpayer filed its tax return to assess a tax against a taxpayer. However, if a taxpayer omits an item from gross income on its return that is in excess of 25% of the amount of gross income stated on the return, the period for assessment is extended from three years to six years.  In holding that an overstatement of basis does not constitute an omission for this purpose, Home Concrete invalidates final Treasury regulations issued in 2010 that would have applied the extended six-year statute of limitations to overstatement of basis transactions retroactively.

Background  

Disputes between taxpayers and the IRS regarding whether an overstatement of basis can subject a taxpayer to the extended six-year statute of limitations period have made their way through the courts since 2009.

Multiple federal appeals courts addressed this issue and were split. The Ninth, Fourth and Fifth Circuits held that an overstatement of basis is not an omission from gross income that is subject to the six-year statute of limitations period. See Bakersfield Energy Partners, LP v. Comr., 568 F.3d 767 (9th Cir. 2009), aff'g 128 T.C. 207 (2007); Home Concrete & Supply, LLC v. U.S., 634 F.3d 249 (4th Cir. 2011); and Burks v. U.S., 633 F.3d 347 (5th Cir. 2011). However, the Seventh, Tenth, Federal and District of Columbia Circuits all held that an overstatement of basis is an omission from gross income that triggers the six-year statute of limitations period. See Beard v. Comr., 633 F.3d 616 (7th Cir. 2011); Grapevine Imports, Ltd. v. U.S., 636 F.3d 1368 (Fed. Cir. 2011); Salman Ranch Ltd. v. Comr., 647 F.3d 929 (10th Cir. 2011); Intermountain Ins. Serv. of Vail, LLC v. Comr., 650 F.3d 691 (D.C. Cir. 2011), rev'g T.C. Memo 2009-195; and UTAM, Ltd. v. Comr., 645 F.3d 415(D.C. Cir. 2011), rev'g T.C. Memo 2009-253.

In 2010, while multiple cases on the issue were in litigation, the IRS and Treasury issued final regulations providing that "an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission from gross income" for purposes of §§6229(c)(2) and 6501(e)(1)(A).

Supreme Court Decision in Home Concrete  

In a five-to-four decision, the Supreme Court affirmed the Fourth Circuit's holding in Home Concrete in favor of the taxpayer, primarily relying on the court's earlier decision in Colony Inc. v. Comr., 357 U.S. 28 (1958).  In that case, the Court concluded that an overstatement of basis did not constitute an omission from gross income under former §275(c) of the Internal Revenue Code of 1939, the predecessor to § 6501(e)(1)(A).

The Supreme Court noted that Colony focused on the word "omit," particularly the phrase "omits … an amount," and that the term "`omit' limits the statute's scope to situations in which specific receipts or accruals of income are left out of the computation of gross income; to inflate the basis, however, is not to `omit' a specific item, not even of profit" (emphasis in original). Although Colony interpreted a predecessor statute, the Supreme Court stated that §6501(e)(1)(A) is a reenactment of the 1939 provision interpreted in Colony, and that "[t]he operative language is identical. It would be difficult, perhaps impossible, to give the same language here a different interpretation without effectively overruling Colony, a course of action that basic principles of stare decisis wisely counsel us not to take."

The Supreme Court also rejected the U.S. Government's argument that the 2010 final regulations should be given deference under Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984). The Government argued that under National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967, 982 (2005), a "court's prior judicial construction of a statute 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 … " (emphasis added). The Government noted that the Supreme Court stated in Colony that "it cannot be said that the language is unambiguous," and thus, the issue is whether the final regulations are a permissible construction of the statute.

In rejecting the Government's contention, the plurality opinion authored by Justice Breyer stated in Home Concrete that "[i]n our view, Colony has already interpreted the statute, and there is no longer any different construction that is consistent with Colony and available for adoption by the agency." Moreover, the Supreme Court noted that the examination of the legislative history of the predecessor to §6501 in Colony led the Supreme Court in that case to conclude that "Congress had decided the question definitively, leaving no room for the agency to reach a contrary result." Therefore, the plurality of the Court concluded that the Colony decision makes clear that the statute did not leave a gap for the regulations to fill. Justice Scalia concurred with the plurality's determination that Colony was controlling, but disagreed with the plurality's implication that a court's construction of a statute can only trump Treasury regulations otherwise entitled to Chevron deference if the language in the statute is unambiguous. The dissenting opinion, authored by Justice Kennedy, concluded that the 2010 Treasury regulations were entitled to Chevron deference.

Home Concrete is significant for all taxpayers, and may have a particular impact on partnership audits pursuant to which the IRS may attempt to challenge the tax consequences of partnership interest transfers, redemptions or property contributions that resulted in a basis increase pursuant to a §754 election or otherwise.

 For more information, in the Tax Management Portfolios, see Mather, 624 T.M., Audit Procedures for Pass-Through Entities, Peyser, 627 T.M., Limitations Periods, Interest on Underpayments and Overpayments, and Mitigation and in Tax Practice Series, see ¶3860, Statute of Limitations.

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