Split widens as courts hold basis overstatement is not income omission.

• Author: Beavers, James A.

The ongoing controversy over whether a taxpayer's overstatement of basis triggers a six-year statute of limitation period continues as the Fourth Circuit and Fifth Circuit both held within days of each other that the extended period does not apply. These decisions are at odds with a Seventh Circuit opinion issued in January and with regulations finalized in December (T.D. 9511).

Background

The taxpayers in the Fourth Circuit case, Home Concrete, had artificially overstated their basis in their LLC interests through a series of transactions that, according to the IRS, lacked economic substance and therefore had underre-ported gain from the sale of those interests. The IRS argued that this amounted to an omission from gross income, and therefore the longer six-year period to assess the tax due applied. In the Fifth Circuit case, Burks, the taxpayers had engaged in a son-of-boss tax shelter to create artificial tax losses to offset capital gains. As a result of various transactions, the taxpayers ended up with inflated bases in their partnership assets.

Under Sec. 6229(c)(2), if a partnership "omits from gross income" an amount that should be included and that exceeds 25% of the amount of gross income stated in its return, the period for assessing tax attributable to its partnership items is extended to six years. Similarly, Sec. 6501(e)(1)(A) provides that if a taxpayer omits from gross income an amount that should be included and that exceeds 25% of the amount of gross income stated in the return, the period of time for assessment is extended to six years. Sec. 6501(e)(1)(A) also defines the term "gross income."

After losing earlier litigation on the topic, the IRS issued final regulations that define gross income, as it relates to a trade or business, as "the total of the amounts received or accrued from the sale of goods or services, to the extent required to be shown on the return, without reduction for the cost of those goods or services" (Regs. Secs. 301.6229(c)(2)-1(a)(1)(ii) and 301.6501(e)-1(a)(1)(ii)). The regulations further state that gross income, as it relates to any income other than from the sale of goods or services in a trade or business, "has the same meaning as provided under Sec. 61(a), and includes the total of the amounts received or accrued, to the extent required to be shown on the return" (Regs. Sees. 301.6229(c)(2)-1(a) (1)(iii) and 301.6501(e)-1(a)(1)(iii)).

Previous Court Decisions

Prior to the Burks and Home...