Temporary regs. held invalid.

• Author: Beavers, James A.

The Tax Court handed the IRS a double loss, holding that temporary regulations it issued after an earlier adverse decision did not apply to that case and that the temporary regulations were invalid because they were contrary to the Supreme Court's opinion in Colony, Inc., 357 U.S. 28 (1958).

Background

Intermountain Insurance Service of Vail, LLC (Intermountain), engaged in a series of transactions--some of which increased tax basis--culminating in the sale of business assets on August 1, 1999, for $1,918,844. It reported the $1,918,844 gross sales price and, after deducting $131,544 of allowed or allowable depreciation, claimed a stepped-up $2,061,808 basis in the assets on its 1999 return filed on September 15, 2000.

Almost six years later, on September 14, 2006, the IRS issued a notice of final partnership administrative adjustment (FPAA) with respect to Intermountain's 1999 tax year. The IRS found that some of the transactions Intermountain engaged in were improper and ineffective for federal income tax purposes and consequently determined that Intermountain had improperly overstated capital contributions by $2,197,696 and overstated outside partnership basis by $2,061,808.

The IRS asserted that because of Intermountain's understatement of income due to its substantial basis overstatements on the 1999 return, the return's period of limitation for assessment was extended to six years under Secs. 6229(c)(2) and 6501(e)(1)(A). These sections state that the period of limitation for assessment remains open for six years if a taxpayer (Sec. 6501(e)(1)(A)) or a partnership (Sec. 6229(c)(2)) omits an amount from gross income in excess of 25% of reported gross income. Intermountain challenged the timeliness of the FPAA in Tax Court, arguing that the general three-year limitation period had already expired when the IRS issued the FPAA and that, consistent with the Tax Court's earlier opinion in Bakersfield Energy Partners, LP, 128 T.C. 207 (2007), an omission from gross income does not include an understatement of income caused by an overstatement of basis, so the six-year limitation period did not apply.

The Tax Court's Initial Decision

The Tax Court declined to reverse its holding in Bakersfield and held that the six-year limitation period did not apply (Intermountain Ins. Serv. of Vail, LLC, T.C. Memo. 2009-195). It explained that in Bakersfield it had applied the Supreme Court's holding in Colony, stating that "the extended period of...