TC ruling on six-year SOL.

• Author: Packard, Pamela
• Position: Statute of limitations for assessing tax deficiencies

In Harlan, 116 TC No. 4 (2001), the Tax Court ruled that a partner in a partnership that itself is a partner in another partnership can include in gross income his share of both partnerships' gross income for purposes of the six-year statute of limitations (SOL) for assessing tax deficiencies under Sec. 6501(e). The ruling increases the probability that a taxpayer will not be subject to the six-year rule, and instead the normal three-year SOL will apply.

In general, Sec. 6501(a) bars assessment of an income tax deficiency more than three years after the later of the date the return was filed or due. Sec. 6501(e) provides for a six-year SOL if a taxpayer improperly omits from gross income more than 25% of "the amount of gross income stated in the return." The correct amount of gross income is therefore not part of the fraction in applying this six-year rule. Case law has established that the Service has the burden of proving that the 25% test is satisfied. "Gross income" has a well-established meaning under Sec. 61(a), which contains a partial list of items includible in gross income. Sec. 6501(e)(1)(A) contains two modifications: (1) gross income from a trade or business is not reduced by the cost of sales and (2) items adequately disclosed in the return are not deemed omitted.

A partnership is not a taxable entity; however, it must file an information return. Under Sec. 702(a) and (b), partners take into account their share of partnership items on their individual returns, and these items retain their character. Sec. 702(c) requires that whenever a partner's gross income is to be determined, he must include his distributive share of the partnership's gross income.

Ridge and Marjorie Harlan were partners in several first-tier partnerships. Two of these partnerships, Carlyle and Pacific, were partners in one or more other partnerships, making them second-tier partnerships. In June 1992, the IRS issued a deficiency notice for their 1985 return. The issue in Harlan is how to calculate the taxpayer's "gross income stated in the return" under Sec. 6501(e) when the taxpayer is a partner in tiered partnerships.

The parties stipulated that the Harlans' gross income was $1,410,077, which included the gross income from their first-tier partnerships but included only net income or loss amounts from the second-tier partnerships. (These net amounts flowed from the second-tier to the first-tier partnerships.) The record in Harlan did not contain the...